Little Creek Development Co., Matter of

• Decision Date: 03 January 1986
• Docket Number: No. 85-1615,85-1615
• Citation: 779 F.2d 1068
• Parties: 13 Collier Bankr.Cas.2d 1231, 13 Bankr.Ct.Dec. 1407, Bankr. L. Rep. P 70,909 In the Matter of LITTLE CREEK DEVELOPMENT COMPANY, Debtor. LITTLE CREEK DEVELOPMENT CO., Plaintiff-Appellant, v. COMMONWEALTH MORTGAGE CORP., Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1068

779 F.2d 1068

13 Collier Bankr.Cas.2d 1231, 13 Bankr.Ct.Dec. 1407,

Bankr. L. Rep. P 70,909

In the Matter of LITTLE CREEK DEVELOPMENT COMPANY, Debtor LITTLE CREEK DEVELOPMENT CO., Plaintiff-Appellant, v. COMMONWEALTH MORTGAGE CORP., Defendant-Appellee.

No. 85-1615.

United States Court of Appeals Fifth Circuit.

Jan. 3, 1986.

Adams, Meier, Addison & Assoc., John T. Lynch, IV, David L. Whaley, Peter H. Fulton, Hurst, Tex., for plaintiff-appellant.

Locke, Purnell, Boren, Laney & Neely, David Blanke, Larry M. Lesh, Dallas, Tex., for defendant-appellee.

Appeals from the United States District Court for the Northern District of Texas.

Before POLITZ, HIGGINBOTHAM and JONES, Circuit Judges.

EDITH HOLLAN JONES, Circuit Judge.

The debtor, Little Creek Development Company (Little Creek), appeals from an order of the bankruptcy court lifting the automatic stay so that the secured creditor, Commonwealth Mortgage Corporation (Commonwealth), could foreclose on Little Creek's single asset, two parcels of undeveloped real estate. The principal issue on appeal is whether the bankruptcy court was clearly erroneous in finding that "cause" to lift the stay pursuant to 11 U.S.C. Sec. 362(d)(1) could be based solely on the remarks of counsel for Little Creek that the bankruptcy petition was filed in order to escape the necessity of posting a substantial bond in an ongoing state court proceeding. We find that more evidence was necessary to support the bankruptcy court's conclusions, and we therefore remand with instructions.

I. BACKGROUND

Little Creek obtained a loan from Commonwealth for the purpose of developing town homes on two tracts of land in Hurst, Texas, a suburb of Dallas. In March 1984, the parties signed promissory notes, deeds of trust, and other financing documents that would commit Commonwealth to fund up to $4.7 million for the project. Little Creek purchased the tracts of land for $675,000, but was unexpectedly delayed in obtaining building permits from the City of Hurst. Little Creek has not yet broken ground on the project. In January 1985, Commonwealth informed Little Creek of its intention to accelerate the debt and foreclose its mortgages, based on Little Creek's failure to obtain building permits and a satisfactory replacement guarantor.

Little Creek preempted foreclosure proceedings in March by filing a wide-ranging complaint in state court, alleging causes of action based upon the Texas Deceptive Trade Practices Act, breach of contract, and unconscionability. An ex parte temporary restraining order was issued against foreclosure. In early May, Little Creek obtained a preliminary injunction, conditioned upon its posting a bond for $50,000 to forestall foreclosure during the month of May, and thereafter, a bond for $1,250,000 pending the conclusion of the litigation. Little Creek could not post the required larger bond in June.

Again staving off foreclosure, Little Creek filed a petition for reorganization under Chapter 11 of the Bankruptcy Code. Commonwealth moved in the bankruptcy court for relief from the automatic stay, 11 U.S.C. Sec. 362(d), seeking to foreclose the property. Little Creek's response to that motion defensively raised most of the issues presented in the pending state court action. Little Creek also sought leave to take numerous depositions and to engage in extensive discovery.

The bankruptcy court held two hearings on the motion for relief from the stay. In the first hearing, Commonwealth indicated that Little Creek's debt exceeded $1,400,000, and that its mortgage was perfected. Through an appraiser, Commonwealth claimed that the value of Little Creek's property was only $775,000. Due to the court's time constraints, Little Creek neither pursued its questions concerning the amount of the debt nor completed its cross-examination of Commonwealth's appraiser. By the time of the second stay hearing, the bankruptcy court had granted a motion to strike Little Creek's defenses, finding them inappropriate for consideration in that context, whereupon counsel for Little Creek uttered candid remarks. In attempting to explain why Little Creek should be allowed to present evidence of alleged modification of the loan agreements, counsel stated:

The Debtor in this case has already sought and obtained an injunction in State Court against the foreclosure sale and was unable to continue that by virtue of an increasing bond requirement. And that was the reason it [precipitated] this filing in this court. * * * And we feel like this is the proper [forum] to consider the issues relative to a proper acceleration of the debt and foreclosure sale because we don't feel like there's any other [forum] available to the Debtor in this case.

Co-counsel then reiterated the debtor's position:

Now, if we were able to carry forward with that type of bond, we'd still be in State Court. The reason we're in Bankruptcy Court is because the sole asset of the corporation is [jeopardized] by the fact that the lenders committed some acts, which we've alleged to this court. The same reasoning by going to State Court for our remedy--going to State Court for our remedy isn't applicable here. Because State Court has granted our remedy, we're not able to bond the amount in State Court and that's why we're in Bankruptcy Court seeking our remedy here.

Based on these representations, which Little Creek's counsel later sought to modify, the court sua sponte found that

the admissions of counsel coupled with Little Creek's prior attempts to incorporate the state court causes of action into the stay litigation make it readily apparent that Little Creek simply wanted to transfer the litigation from state court to bankruptcy court where it could have an automatic injunction and escape the state court's bond requirement.

These actions, in the bankruptcy court's view, rendered the debtor's petition for reorganization a "bad faith" proceeding. The court, 54 BR 510, subsequently entered an order granting Commonwealth relief from the stay for "cause," finding that Little Creek lacked good faith in filing the petition. The district court affirmed the bankruptcy court's disposition.

This court temporarily stayed the lift pending expedited appeal, and our jurisdiction to review the final order of the bankruptcy court derives from 28 U.S.C. Sec. 158(d). Because we have concluded that the record was insufficiently developed to justify the bankruptcy court's conclusion, it is desirable to provide guidance for the court's benefit on remand. ¹

II. THE GOOD FAITH PRINCIPLE AS "CAUSE" FOR LIFTING THE STAY

Bankruptcy is an equitable remedy whereby a debtor is clothed with the protection of an automatic stay, preventing his creditors from acting against him for a period of time, in order to facilitate rehabilitation or reorganization of his finances and to promote a "fresh start" through the orderly disposition of assets to satisfy his creditors. See GATX Aircraft Corp. v. M/V COURTNEY LEIGH, 768 F.2d 711, 716 (5th Cir.1985); In re Sun Country Dev., Inc., 764 F.2d 406, 408 (5th Cir.1985); In re Winshall Settlor's Trust, 758 F.2d 1136, 1137 (6th Cir.1985); Browning v. Navarro, 743 F.2d 1069, 1083 (5th Cir.1984). Every bankruptcy statute since 1898 has incorporated literally, or by judicial interpretation, a standard of good faith for the commencement, prosecution, and confirmation of bankruptcy proceedings. See In re Victory Constr. Co., 9 B.R. 549, 551-60 (Bankr.C.D.Cal.1981) (containing an excellent historical survey). See, e.g., Fidelity Assur. Assoc. v. Sims, 318 U.S. 608, 621, 63 S.Ct. 807, 813-14, 87 L.Ed. 1032 (1943); A-COS Leasing Corp. v. Wheless, 422 F.2d 522, 523-25 & n. 1 (5th Cir.1970). Such a standard furthers the balancing process between the interests of debtors and creditors which characterizes so many provisions of the bankruptcy laws and is necessary to legitimize the delay and costs imposed upon parties to a bankruptcy. Requirement of good faith prevents abuse of the bankruptcy process by debtors whose overriding motive is to delay creditors without benefitting them in any way or to achieve reprehensible purposes. Moreover, a good faith standard protects the jurisdictional integrity of the bankruptcy courts by rendering their powerful equitable weapons (i.e., avoidance of liens, discharge of debts, marshalling and turnover of assets) available only to those debtors and creditors with "clean hands." The Supreme Court aptly summarized the bankruptcy court's responsibility to enforce a standard of good faith when it stated:

"A court of equity may in its discretion in the exercise of the jurisdiction committed to it grant or deny relief upon performance of a condition which will safeguard the public interest." ... These principles are a part of the control which the court has over the whole process of formulation and approval of plans of composition or reorganization....

American United Mut. Life Ins. Co. v. City of Avon Park, 311 U.S. 138, 145, 61 S.Ct. 157, 161-62, 85 L.Ed. 91 (1940) (quoting SEC v. United States Realty & Improvement Co., 310 U.S. 434, 455, 60 S.Ct. 1044, 1053, 84 L.Ed. 1293 (1940)).

Like its predecessor statutes, and based on the foregoing considerations, the Bankruptcy Code of 1978 has been endowed with requirements of good faith in the construction of many of its provisions. See Ordin, The Good Faith Principle in the Bankruptcy Code: A Case Study, 38 Bus.Law. 1795 (1983). See also Winshall Settlor's Trust, 758 F.2d at 1137; In re Moog, 774 F.2d at 1077; Coastal Cable T.V., 709 F.2d at 764-65. Litigation concerning good faith which is pertinent to this case has arisen under Sec. 362(d) of the Bankruptcy Code, 11 U.S.C. Sec. 362(d)(1), governing relief from the automatic stay, and under 11 U.S.C. Sec. 1112(b), which permits dismissal or conversion of a reorganization case. Both of these provisions allow relief to be granted "for cause," a term not defined in the statute so as to afford...