In re Staff Inv. Co.
| Decision Date | 05 January 1993 |
| Docket Number | Bankruptcy No. 92-20307-C-11. |
| Citation | 146 BR 256 |
| Court | U.S. Bankruptcy Court — Eastern District of California |
| Parties | In re STAFF INVESTMENT CO., Debtor. |
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Maria E. Lara, Shingle Springs, Cal., for debtor.
Judith C. Hotze, Office of U.S. Trustee, Sacramento, Cal., for U.S. Trustee.
Martin L. Smith, Orrick, Herrington & Sutcliffe, Sacramento, Cal., for creditor Security Pacific Credit Corp.
Here is another way to handle the pesky problem of serial bankruptcies that are filed as maneuvers to milk unfair advantage from the Bankruptcy Code. After a creditor won relief from the automatic stay fair and square, this real estate partnership averted conversion from chapter 11 to chapter 7 by inveigling dismissal of the case. Then it bagged a new automatic stay by filing a chapter 7 case.
Although invited to dismiss the second case as a bad faith filing, a less drastic alternative is afforded by the incorporation of Federal Rule of Civil Procedure 60 into Federal Rule of Bankruptcy Procedure 9024. Where applicable, the alternative preserves the integrity of the relief from stay proceedings in the first case and finesses the conceptual complications inherent in denying all bankruptcy relief.1
The order dismissing the first bankruptcy case will be vacated. An order converting the case to chapter 7 will be substituted in light of the debtor's manifested desire to maintain a bankruptcy case. As the first case will thereby be restored to active status, the second case will be dismissed in abatement as in the nature of a prior suit pending and as an interference with the estate that was created upon the filing of the first case.2
The debtor general partnership filed this chapter 11 case to protect its primary asset, real estate encumbered by a deed of trust securing $1.9 million owed to Security Pacific Bank ("Security Pacific"). It is not otherwise actively engaged in business. Unsecured debt owed to others (excluding insider debt) is $21,000.
Security Pacific obtained relief from the automatic stay. The property was worth only $1.3 million and was not necessary for an effective reorganization. The debtor actually contested the motion. The decision was rendered on the merits based on findings of fact and conclusions of law stated orally on the record in open court following the close of the evidence.3 The order granting relief from stay was not appealed and became final.
The United States trustee subsequently moved to dismiss or convert to chapter 7 for cause under 11 U.S.C. § 1112(b) on theories of continuing loss to or diminution of the estate and absence of reasonable likelihood of rehabilitation. Moments before the hearing on that motion, debtor's counsel told the United States trustee's counsel that, as the property had been "lost to foreclosure," there was no need for a bankruptcy case and persuaded her to urge that dismissal, rather than conversion to chapter 7, was in the best interest of creditors and the estate. The case was dismissed.
The truth, however, was that the property had not yet been lost. The foreclosure sale had not been held. The debtor was marketing the property and knew that an offer was being made that very day in the approximate amount of the debt to Security Pacific.4
The debtor intended to block the foreclosure with a new bankruptcy case and new automatic stay. Had the truth been known, the case would have been converted to chapter 7 and not dismissed.
The filing of the chapter 7 case provoked a counterbarrage of motions to vacate the dismissal and convert the prior case to chapter 7, to lift the automatic stay under principles of res judicata,5 and to dismiss the new case as a bad faith filing.
A motion made under section 1112(b) gives the court the option of dismissing or converting, regardless of whether the motion itself seeks only dismissal or only conversion. Upon the requisite showing of cause under section 1112(b), it is up to the court to choose between dismissal or conversion, "whichever is in the best interest of creditors and the estate."6
The court's choice between conversion and dismissal has important consequences. If this case had been converted to chapter 7, the order lifting the automatic stay would have remained in effect.7 By dismissing and then filing a chapter 7 case, the debtor obtained a new automatic stay.
The standard for choosing conversion or dismissal based on "the best interest of creditors and the estate" implies a balancing test to be applied through case-by-case analysis. In the end, the determination is a matter for sound judicial discretion. 5 L. King, Collier on Bankruptcy ¶ 112.032d.
The element of the best interest of creditors resolves itself primarily to the interest of Security Pacific, which is the sole secured creditor and which has 95 percent of the unsecured debt as a result of the $600,000 shortfall in the value of its collateral. As Security Pacific had obtained permission to proceed with foreclosure, its interest favors keeping the bankruptcy case open so that the relief from the automatic stay remains unambiguously effective while it proceeds with foreclosure.
It is not necessary that the interest of every creditor actually favor conversion. There is no specific numerosity requirement inherent in section 1112(b) best interest test. The interest of a single creditor with a large enough claim will suffice. Goodrich v. Lines, 284 F.2d 874, 877 (9th Cir.1960) (Bankruptcy Act). Here, the interest of Security Pacific is sufficient to warrant conversion without regard to the other unsecured creditors, because the unsecured amount owed Security Pacific comprises more than 95 percent of the total unsecured debt.
Nevertheless, the best interest of other unsecured creditors (except insiders) does not necessarily cut against conversion. The debtor's argument that the unsecured creditors (none of whom were heard from) would fare better outside of bankruptcy (or with foreclosure stayed indefinitely) overlooks the possibility that a chapter 7 trustee could reach other assets on several theories.
A chapter 7 trustee has a veritable arsenal of bankruptcy and nonbankruptcy rights. The trustee's basic bankruptcy avoiding powers may bear fruit. The trustee has a claim, based on federal law, against each of the general partners for any insufficiency of assets to pay liabilities. 11 U.S.C. § 723. And there are state law rights. Under both California law and the Uniform Partnership Act, the assets of a partnership include the contributions of partners necessary for payment of all liabilities owing to creditors. Cal.Corp.Code § 15040; Uniform Partnership Act § 40. Thus, the unsecured creditors may be no worse off in chapter 7 than outside of bankruptcy entirely.
The element of the best interest of the estate focuses upon whether the economic value of the estate is greater inside or outside of bankruptcy. The estate is defined in terms of interests in property. 11 U.S.C. § 541(a). It is a broad definition that sweeps in, for example, the trustee's rights to recover property. 11 U.S.C. § 541(a)(3). As the trustee's powers to recover property are generally greater than would be available outside of bankruptcy,8 this factor tends to favor conversion where there is not continuing revenue-generating activity.
The best interest of the debtor is not specifically a factor under section 1112(b). The Congress omitted specific reference to the interest of the debtor when it required focus on "best interest of creditors and the estate." 11 U.S.C. § 1112(b).
Is omission of the interest of the debtor from the statutory language significant or just sloppy draftsmanship? The language of related provisions in the same statute shows that it is significant. Under the abstention provision, a case can be dismissed if the "interests of creditors and the debtor would be better served" by such actions. 11 U.S.C. § 305(a). The Congress knew how to make the debtor's interest a factor in section 1112(b) and chose not to do so.
The debtor's interests do enter the equation, but only insofar as they coincide with interests of the estate.9 Those interests, it need hardly be said, do not always coincide. As already noted, the prime criterion for assessing the interest of the estate is the maximization of its value as an economic enterprise. Persons in control of the debtor commonly have other interests that are inconsistent with vigorous maximization of the value of the economic enterprise.
At the time of the decision to dismiss this case, the calculus tipped in favor of dismissal only if the debtor did not intend to file a new bankruptcy. Security Pacific, having obtained relief from stay, was better off with the case remaining in bankruptcy. Other creditors and the estate, faced with the actual prospect of losing the real property to Security Pacific, would fare better in chapter 7 because of the availability of the trustee's avoiding powers as other sources of value. Moreover, the absence of business activity by the debtor suggested little opportunity for enhancing estate value outside of bankruptcy.
Under bankruptcy procedure, a motion to dismiss or convert a case pursuant to section 1112(b) is a "contested matter" that is processed as a motion rather than as a separate adversary proceeding. Fed. R.Bankr.P. 1017(d) and 9014.10 Contested matters come to issue on a much faster track but share many familiar procedures with adversary proceedings and civil actions.11
Although commonly titled as an "order", the document resolving a...
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