In re Victory Const. Co., Inc.

• Decision Date: 26 January 1981
• Docket Number: Bankruptcy No. LA-80-07936-RO,Adversary No. 80-2131-RO.
• Citation: In re Victory Const. Co., Inc., 9 B.R. 549, 7 B.C.D. 257 (Bankr. C.D. Cal. 1981)
• Court: U.S. Bankruptcy Court — Central District of California
• Parties: In re VICTORY CONSTRUCTION CO., INC., Debtor.

9 B.R. 549 (1981)

In re VICTORY CONSTRUCTION CO., INC., Debtor.

Bankruptcy No. LA-80-07936-RO, Adversary No. 80-2131-RO.

United States Bankruptcy Court, C.D. California.

January 26, 1981.

Gilbert Robinson & Gary E. Klausner of Robinson, Wolas & Diamant, Los Angeles, Cal., for debtor.

William C. Moritz of Donnelly, Clark & Chase, Los Angeles, Cal., for plaintiff John H. Hadley.

Mason Brown of Brown & Brown, P.C., Los Angeles, Cal., for plaintiff Fred B. Green.

MEMORANDUM OPINION ON COMPLAINT TO VACATE STAY FOR CAUSE (LACK OF GOOD FAITH OF THE DEBTOR IN FILING ITS PETITION UNDER CHAPTER 11)

ROBERT L. ORDIN, Bankruptcy Judge.

1. Introduction

On August 11, 1980, Victory Construction Co., Inc., a California corporation (hereinafter "Victory") filed a petition under Chapter 11. The debtor's sole asset is a parcel of improved real property known as 8511 Beverly Place, Los Angeles, California (hereinafter called the "real property"). It is subject to the following liens of record:

A first trust deed in favor of
                  California Federal Savings and
                  Loan, securing an unpaid obligation
                  of $221,338.36, including
                  principal and interest ....                  $221,338.36
                A second trust deed in favor of
                  Japan California Bank, securing
                  an unpaid obligation of
                  $346,639.07, including principal
                  and interest (plus attorneys'
                  fees disputed in amount but
                  which the bank claims in the
                  sum of $50,000) .....................         346,639.07
                A third trust deed in favor of
                  John Hadley and others, securing
                  an unpaid obligation of $1,354,056.24
                  including principal
                  and interest (plus attorneys'
                  fees disputed in amount, but
                  which Hadley claims in the
                  sum of $80,000) ....................        1,354,056.04
                A fourth trust deed in favor of
                  Japan California Bank, securing
                  an unpaid obligation of
                  $346,639.07, including principal
                  and interest (plus attorneys'
                  fees) ..............................          346,639.07
                A lien for taxes due the County
                  of Los Angeles in the approximate
                  sum of $30,000 .....................           30,000.00
                A mechanic's lien securing an unpaid
                  obligation to Green of
                  $576,714.74, including principal
                  and interest .......................          576,714.74
                A mechanic's lien to Decorative
                  Carpets, securing an unpaid
                  balance of $23,891.23, including
                  principal and interest ....                    23,891.23
                                                               ___________
                             Total liens ..............      $2,899,278.71
                

On August 20, 1980, nine days after the debtor filed its petition, Japan California Bank, Hadley, Green, and Decorative Carpets filed a complaint seeking:

(i) Relief from the automatic stay against lien enforcement; or

(ii) Dismissal of the debtor\'s petition as not having been filed in good faith.

The trial of these issues began on October 20, 1980.¹ Immediately prior to the commencement of the trial, Japan California Bank (hereinafter "JCB") entered into a stipulation with the debtor permitting entry of a judgment vacating the stay against JCB, on condition that JCB would not execute on the judgment so long as payments were made in accordance with an agreement referred to in the stipulation, and on the further condition that no other creditor with a lien on the property was granted leave to foreclose.² The foregoing stipulation and judgment were approved by the court on October 20, 1980, before trial commenced, whereupon JCB withdrew its request for relief and did not participate further in the litigation. The trial of the remaining issues was joined between the plaintiffs Hadley, Green, and Decorative Carpets (hereinafter "plaintiffs"), and the debtor-defendant (hereinafter "Victory").

2. The issues to be determined

Plaintiffs seek an order vacating the automatic stay and permitting foreclosure of their defaulted liens, for cause. They assert as "cause": (a) that Victory did not file its Chapter 11 petition in "good faith"; (b) that plaintiffs have neither received nor been offered "adequate protection" of their interest in the property;³ and (c) that Victory has no equity in the real property, and the property is not necessary to an effective reorganization. In addition, plaintiffs assert that the debtor's lack of good faith in filing the petition requires the court to dismiss the Chapter 11 case in its entirety.

3. The "good faith" issue

The "good faith" issue may be analyzed as follows:

(1) Does a debtor's lack of "good faith" in filing a Chapter 11 case constitute "cause" to vacate the automatic stay under § 362(d)(1)?

(2) Does the law impose a "good faith" condition on debtor's right to file or maintain a proceeding under Chapter 11?

If the answer to these questions is negative, plaintiff's right to relief in this case is limited to a consideration of the issues of adequate protection, the existence of equity, and whether the property is necessary to an effective reorganization.

(3) Was the debtor's petition in this case filed in "good faith"?

"Good faith" as a standard of confirmation in debtor rehabilitation or reorganization proceedings, or as a condition to the debtor's right to file and maintain proceedings aimed at rehabilitation or reorganization, has appeared in many provisions of the Bankruptcy Act of 1898; and the courts have explored the meaning of the term in a wide variety of fact situations and circumstances. While many of the cases merely use the term or refer to "good faith" provisions of the statutes without contributing to an understanding of its meaning, a large number of cases attempt and make a meaningful analysis and contribute to an understanding of the concept. Some of these cases are collected in the Appendix to this opinion.

As the cases disclose, however, judicial analysis of the meaning, scope, and dimension of "good faith" in rehabilitation or reorganization cases has not differentiated between the "good faith" required to confirm a plan of arrangement, and the "good faith" required at the outset as a condition of the right to file and maintain the proceeding. Moreover, an understanding of the cases requires some knowledge of the provisions of the statutes to which they refer and an appreciation of the purposes and philosophies embodied in these laws.

Accordingly, a cursory examination of the provisions and purposes of these statutes will be useful.

(i) Section 12 (1898)

This section permitted a bankrupt to offer terms of composition to creditors, and authorized the court to confirm the proposal upon stated conditions. The effect of this composition was to supercede the bankruptcy proceedings and revest the bankrupt with all his property, free of the claims of creditors. Rider, 96 Fed. 808 (N.D.N.Y. 1899). It was the duty of the judge, upon request for confirmation, to confirm if the standards set forth in the section were complied with. Weintrob, 240 Fed. 532 (E.D.N.C.1917); Adler v. Jones, 109 Fed. 967 (6th Cir. 1901); McLellan, 204 Fed. 482 (N.D.N.Y.1913). No offer of composition could be confirmed by the court, however, unless

(3) the offer and its acceptance are in good faith, and have not been made or procured except as herein provided, or by any means, promises, or acts herein forbidden. Section 12(d)(3)

This "good faith" requirement was a condition of confirmation. It was not expressed as a condition of the right to initiate the bankruptcy proceeding.

(ii) Section 74 (1933)

This section permitted individuals, not corporations, to seek a composition or extension with creditors. Upon the filing of the petition, the judge was required to approve the petition if satisfied that it was filed in "good faith," and if not, to dismiss it. Section 74(a) The court was authorized to confirm the proposal, if satisfied, among other things, that:

(4) The offer and its acceptance are in good faith, and have not been made or procured except as herein provided, or by any means, promises or acts herein forbidden. 74(g)(4)

"Good faith" was required as a condition to filing, and was required in order to confirm a proposed composition or extension.

Section 74 was intended to provide relief to persons who, finding themselves embarrassed by debts accumulated in the past, desired the opportunity to submit terms of compromise to their creditors. In re Cosgrave, 10 F.Supp. 672 (Calif.1935). The section did not contemplate immediate liquidation but a postponement, with the hope of ultimate payment and rehabilitation. It was the intent of Congress to open the door to distressed debtors who could exhibit some reasonable expectation of paying their debts if given an extension of time. Van Doren, 79 F.2d 859 (7th Cir. 1935). The section contemplated a feasible plan promptly presented whereby the overburdened debtor could, through creditor cooperation, secure a scaling of debt or extension of the due date of the debts. Sterba, 74 F.2d 413 (7th Cir. 1935).

(iii) Section 75 (1933)

Subsections (a)-(r) permitted a farmer to effect a composition or extension of time to pay accumulated debts. The proposal could be confirmed if the court was satisfied that:

(3) The offer and its acceptance are in good faith and have not been made or procured except as herein provided, or by any means, promises, or acts herein forbidden. Section 75(i)(3)

If the farmer failed to obtain the necessary acceptances or otherwise contended that the composition or extension aggrieved him, he could voluntarily elect to be adjudicated a bankrupt, and obtain the benefits of a three-year moratorium against debt collection and lien enforcement upon the terms and conditions provided in the statute. Section 75(s) As in Section 12, Section 75(a)-(r) did not impose a "good faith" condition to initiating the proceeding. There was no reference to "good faith" in Section 75(s).

The plain purpose of Section 75 was to afford relief to farmers who found themselves in economic distress, however severe, by giving them a chance to seek an...