In re Mercury Data Sys., Inc.

• Decision Date: 08 June 2018
• Docket Number: CASE NO. 18–50183
• Citation: 586 B.R. 260
• Parties: IN RE MERCURY DATA SYSTEMS, INC., Debtor
• Court: U.S. Bankruptcy Court — Eastern District of Kentucky

586 B.R. 260

IN RE MERCURY DATA SYSTEMS, INC., Debtor

CASE NO. 18–50183

United States Bankruptcy Court, E.D. Kentucky, Lexington Division.

Signed June 8, 2018

Jamie L. Harris, DelCotto Law Group PLLC, Lexington, KY, for Debtor.

MEMORANDUM OPINION AND ORDER

Gregory R. Schaaf, Bankruptcy Judge

This matter is before the Court on the following: (1) Debtor's Emergency Motion to Alter, Amend, or Vacate Agreed Order and Shorten Notice of Hearing [ECF No. 14 ("Motion to Vacate Agreed Order") ]; (2) Debtor's Notice and Motion for Conversion to Chapter 11 and Request for Shortened and Limited Notice of Hearing [ECF No. 15 ("Motion to Convert") ]; and (3) Debtor's Emergency Motion to Set Aside Order for Relief and/or Dismiss Case for Bad Faith, to Conduct Discovery and to Shorten Notice of Hearing [ECF No. 21 ("Motion to Dismiss") ].

Debtor, Mercury Data Systems, Inc. ("Mercury"), was the subject of an involuntary chapter 7 bankruptcy petition filed in early February 2017. Mercury seeks to set aside the Order for Relief entered a month later and dismiss the chapter 7 bankruptcy based on the bad faith of the petitioning creditors and a failure to satisfy the statutory requirements of 11 U.S.C. § 303.¹ In the alternative, Mercury seeks conversion to chapter 11. Mercury also moves to vacate the Agreed Order Regarding Review of Debtor's Software, which authorizes review of Mercury's primary asset, its software source code [ECF No. 13 (the "Agreed Order to Review Software") ]. Petitioning Creditors (hereafter defined) object and argue Mercury should remain in chapter 7 under the direction of Mark Miller, the Chapter 7 Trustee.

An evidentiary hearing was held on May 24, 25, and 30, 2017. For the reasons stated herein, Mercury's Motion to Dismiss and Motion to Convert are denied. Mercury's Motion to Vacate Agreed Order is granted to allow the parties to consider the substantial additional information available.

I. FACTS.

A. Mercury Data Systems.

Mercury is a software company attempting to develop high accuracy navigation technology. John Taylor is the sole owner and President of Mercury.

Mercury is developing a system for a non-GPS location device called TrakPoint. According to a preliminary business plan created by Taylor to solicit investors, Mercury began developing the current version of the TrakPoint system in 2013 after reaching a performance threshold of 99% accuracy 99% of the time. [Exh. 3, ECF No. 63–3.] Mercury represented that it planned to release the TrakPoint system in 2016 and the technology was so advanced that the Army expressed interest in awarding procurement contracts even before full development of the product. [Id. ] Taylor represented that he anticipated completing the TrakPoint development by July 2018. [Id. ] The preliminary business plan also claimed Mercury would meet certain milestones in 2016, including completing a market analysis, acquiring 5 patents, and acquiring exclusive licensing rights to three different algorithms. [Id. at 10.] Mercury met few of the milestones in 2016 or otherwise, and did not obtain a procurement contract either.

On April 29, 2016, Mercury entered a Note Purchase Agreement with several investors, including Quantum IT Global Holdings Pty Ltd. ("Quantum") and PSP Services Pty Limited ("PSP"). The financing provided $700,000.00 for continuation of research and development on the TrakPoint system and other software. [Exh. 19, ECF No. 68–1.] Mark O'Reilly ("O'Reilly"), owner of PSP and Head of Innovation at Quantum, signed the Note Purchase Agreement on behalf of the investors. The Note Purchase Agreement provided that Mercury would issue convertible promissory notes maturing in 18 months, on or about October 29, 2017. [Id. ]

Mercury encountered financial problems despite the funds received from the investors. Taylor and O'Reilly testified that both knew Mercury was running out of money by March 2017. On March 30, 2017, Quantum agreed to provide additional funds pursuant to a document called Agreed Terms–MDS and A3 Funding ("Agreed Terms"). [Exh. 10, ECF No. 63–9.] O'Reilly signed the Agreed Terms on behalf of Quantum. O'Reilly had concerns about the investment, so Mercury agreed to develop an updated business plan by April 14 for "Plan B Funding" and provide Katherine Bennett, a certified public accountant hired by Mercury, full access to Mercury's financial records. [Id. ]

Bennett was given the promised access, but Taylor did not prepare an updated business plan. Therefore, O'Reilly and Bennett worked on an updated business plan to facilitate solicitation of additional financing that the parties refer to as the "Live Plan." [See Exh. 34, ECF No. 72–12.] They completed the Live Plan in June 2017 and presented it to Taylor for review. [See id. ]

In July 2017, Mercury ran out of money and stopped paying its debts. Alex Stuhl, described in testimony as a key player in TrakPoint's development, and another employee quit. Bennett continued to perform work for Mercury, including aiding O'Reilly with the Live Plan, but her invoices were not paid. [See Exh. 8, ECF No. 63–7 at 5–6.] Mercury's landlord threatened a forcible detainer action, but has not acted. Taylor continued to work on the TrakPoint system, but his visits to the office to perform his managerial duties dwindled to the point that he appeared in the office only once or twice a month.

The loss of employees, potential for eviction, and approaching maturity of the convertible promissory notes caused significant concern for O'Reilly and Bennett. Taylor acknowledged the problems and agreed they had cause for worry. O'Reilly therefore arranged a meeting with Taylor and an Australian company called Codan Limited to discuss a technology partnership with Mercury that would bring in necessary capital and allow Taylor to focus on development issues. [Exh. 48, ECF No. 72–26 at 3.] Taylor expressed no interest in discussing a partnership with Codan. [Id. at 2.]

O'Reilly continued his attempts to find ways to fund development of the TrakPoint system and pay Mercury's creditors without success. Taylor rebuffed O'Reilly's efforts and took no action to find additional funding for Mercury or address Mercury's financial crisis. [See Exh. 51, ECF No. 72–29.] The relationship between O'Reilly and Taylor soured to the point that Taylor ceased communication with O'Reilly.

B. The Involuntary Chapter 7 Petition.

PSP, Peter King, and Bennett ("Petitioning Creditors") filed the involuntary chapter 7 petition against Mercury on February 7, 2018. Mercury did not respond, so the Order for Relief was entered on March 5, 2018. [ECF No. 4.] See also 11 U.S.C. § 303(h).

The Chapter 7 Trustee was appointed and took possession of Mercury's assets. This included changing the locks on the office and discussions with Mercury's employees. See 11 U.S.C. § 704(a). The Chapter 7 Trustee also obtained approval to allow Quantum to "review the quality and efficacy of the Debtor's software" through the Agreed Order to Review Software.

At some point in March, Taylor attempted to access Mercury's office. He discovered the locks were changed, so he could not enter the building. Taylor contacted Chris Creech, a Kentucky lawyer that assisted Mercury with certain transactional matters. Creech discovered the bankruptcy filing and Taylor caused Mercury to become active in this case.

On April 11, Mercury filed the Motion to Vacate Agreed Order and Motion to Convert. The Chapter 7 Trustee and Petitioning Creditors objected to both motions. [ECF Nos. 18, 19, 20.] On April 18, Mercury filed its Motion to Dismiss asking to set aside the Order for Relief under Federal Rule of Bankruptcy Procedure 9024 (incorporating Federal Rule of Civil Procedure 60 ).² [ECF No. 21.] Following a preliminary hearing on April 19, the matters were also set for an evidentiary hearing. [ECF No. 29.]

Petitioning Creditors then filed several amendments to the involuntary petition to add Stuhl [ECF No. 33], Qi Liu [ECF No. 36], Bruce Skeeter [ECF No. 37], Richard J. Tobiano [ECF No. 40], and Edward Kaleel [ECF No. 41] as additional petitioning creditors. Liu and Skeeter are employees of Mercury who are owed outstanding wages. Tobiano and Kaleel invested in Mercury. Also, Mercury supplemented the record with evidence of its ability to operate upon conversion to Chapter 11. [See ECF No. 57.]

Taylor, O'Reilly, and Bennett testified at the evidentiary hearing regarding their involvement with the company and the financial crisis. Creech, Skeeter, and Liu also testified about their work for Mercury. The parties filed numerous proposed exhibits before the evidentiary hearing and the following are admitted without objection: Exhibits 2–5, 8–10, 12–14, 16–19, 21, 26, 30, 32, 34, 36–39, 42–46, 48–53, 59, and 63–67.³ Mercury and/or Petitioning Creditors moved to admit the following Exhibits, but admission was denied for the reasons stated on the record: Exhibits 7, 22, 31, and 35. The remaining Exhibits are not admitted.

II. DISCUSSION.

A. The Request to Set Aside the Order for Relief and Dismiss the Case is Denied.

Mercury moves to set aside the Order for Relief and dismiss this case based on problems with the involuntary petition. Mercury alleges PSP, through O'Reilly, joined as a Petitioning Creditor in bad faith, and there is a bona fide dispute as to Bennett's claim. Mercury argued in its papers and at the evidentiary hearing that these defenses arise out of § 303 and it is entitled to an award of fees, costs and damages pursuant to § 303(i).

Arguments of bad faith and the validity of a petitioning creditor's claim are ripe during the 21–day answer period allowed for objections to the involuntary petition. See 11 U.S.C. § 303(d) ; FED. R. BANKR. P. 1011(a) and (b). These issues were effectively decided in favor of Petitioning Creditors upon entry of the Order for Relief. "An adjudication, and concomitantly an order for relief, is ... a conclusive determination of the debtor's status in bankruptcy, and res judicata between the...