NEIL W. BASON, Bankruptcy Judge.
The debtor's field was genetic testing. That field is "cutting edge," which is not necessarily a good thing from a business standpoint, because historically it was difficult to convince insurers to pay for the debtor's work.
Dr. Steve S. Sommer was the debtor's founder, president, chief medical officer, chief scientist, and chief operating officer ("CEO"). Dkt. 299, p. 2:3-5.
Dr. Sommer did not live up to his fiduciary duties. So this court appointed a chapter 11 trustee. See dkt. 110.
Nevertheless, this court sought to preserve the debtor as a going concern for the benefit of all parties in interest, including not only creditors, employees, and patients, but also Dr. Sommer himself. Because Dr. Sommer was essential to the operation of the business — and giving him the benefit of the doubt that he was well-intentioned, if misguided, in his earlier failure to live up to his fiduciary duties — this court permitted him to continue to operate the debtor under the trustee's supervision. This court also took the extraordinary step of protecting Dr. Sommer by enjoining Wells Fargo's collection efforts against him as guarantor. See dkt. 146; adv. dkt. 15.
Once again, however, Dr. Sommer did not live up to his duties. He made numerous expenditures without authorization from the chapter 11 trustee or this court. To the contrary, the trustee directed Dr. Sommer
Having over-committed the debtor, Dr. Sommer told the trustee that the bankruptcy estate had to hire more staff. When the trustee refused, Dr. Sommer abruptly ceased to generate any additional receivables for October or November, 2016. Dr. Sommer also brought motions to compel the trustee to hire three more employees (dkt. 191), and to reimburse him for $144,238.31 in expenses that he claimed were incurred for the benefit of the bankruptcy estate. Dkt. 196. The trustee, meanwhile, sought to have this case converted from a chapter 11 reorganization to a chapter 7 liquidation.
This court converted this case to chapter 7 (with the trustee continuing to serve as trustee). Dkt. 228. This court also ruled that Dr. Sommer had the burden to show that his expenditures were "actual" and "necessary" expenses of administration, and that he had failed to do so. Nevertheless, this court did allow him $47,488.24 out of the $144,238.31 that he requested because the Trustee had not opposed that reduced dollar amount. Dkt. 264.
Now Dr. Sommer has filed his motion for reconsideration and supporting papers. Dkt. 286, 297, 299. Again, he wants to be compensated for his unauthorized actions, even though the limited resources of this bankruptcy estate will be woefully inadequate to pay creditors, and might well be inadequate to pay the trustee and other administrative expenses.
Dr. Sommer fails to meet the legal standards requiring him to prove that his expenditures were "necessary" to the administration of the estate, not to mention his additional burden to show clear error or other sufficient grounds for relief on a motion for reconsideration. He also fails to cite to specific evidence in the record to support his factual assertions. Moreover, this court previously conducted its own extensive review of the evidence in the record, and has now reexamined the record, and the record does not support Dr. Sommer's position. For all of these reasons, his motion will be denied by a separate order.
On April 5, 2016 (the "Petition Date") the debtor filed its voluntary chapter 11 petition. This court held numerous hearings, often on shortened notice at Dr. Sommer's request. Prior to those hearings this court generally issued detailed tentative rulings, directing the parties to issues of particular concern to this court. Except as modified, those tentative rulings were adopted as this court's final findings of fact and conclusions of law. See, e.g., dkt. 224, 225, 264.
This court granted the debtor authority to use cash collateral, but only on a limited basis. See, e.g., dkt. 20 at p. 4, para. 7, and dkt. 37, 53, 139. At first the primary interest in the cash collateral appeared to be held by Wells Fargo; later by a different creditor ("Socket"), but in any event, under Section 363(c) a debtor in possession is not permitted to use cash collateral without authorization from the Bankruptcy Court (or the consent of all creditors with an interest in the cash collateral).
Nevertheless, Dr. Sommer appeared to have used cash collateral to pay employees without court authorization. He later recharacterized those payments, but ultimately it does not matter how they are characterized because all alleged versions of the facts violated his duties.
In paying the employees he either caused the debtor to use cash collateral without authority (violating Section 363(c)), or he made an unauthorized loan to the debtor (violating Section 364), or (he later claimed) he paid the debtor's employees directly out of his own funds, which created what he now claims is an obligation of the debtor (thereby violating Section 363(b) and 364). In any event he did not disclose those transactions, which hid the debtor's troubled financial condition. In addition, there were unrebutted assertions that under his management the debtor had not paid certain payroll taxes or maintained workers' compensation insurance, and he had caused the debtor to repay loans he allegedly had made to the debtor. See, e.g., dkt. 83, Ex.1&2, and dkt. 159 at p. 2 (belated disclosure of alleged loan repayments to Dr. Sommer).
This court ordered the appointment of a Chapter 11 Trustee, David M. Goodrich (the "Trustee"). Dkt. 114. There was no appeal of that order.
At a hearing on October 11, 2016, the Trustee stated that he had repeatedly spoken with Dr. Sommer about the need to obtain authorization from the Trustee or this court rather than engaging in unauthorized transactions, such as hiring more employees or paying them more than the Trustee authorized. Dkt. 291 (Tr. 10/11/16), pp. 25:23-29:22. Nevertheless, Dr. Sommer stated that, after the Trustee cut payroll, he felt "compelled" to act without authorization from the Trustee or this court. Dkt. 184, p.8:1-4. See also dkt. 297, Ex. A, p. 20:10-16.
On November 23, 2016 Dr. Sommer filed motions, on an emergency basis, to have these and other expenditures treated as allowed administrative expenses (the "Administrative Expense Motion," dkt. 196) and to compel the trustee to hire additional staff (the "Staffing Motion," dkt. 191). Dr. Sommer relies heavily on a "Business Evaluation Summary" (the "Business Plan") prepared by Mr. Michael D'Amato, a business consultant (dkt. 192, p. 2, para. 2 & Ex. B) and also a "Cash Flow Analysis" prepared by Mr. Alex Rachmanony, a Certified Public Accountant, and a partner of Grobstein Teeple LLP (the "CPA Cash Flow Analysis"). Dkt. 191, p. 135 & Ex. C (dkt. 191-3).
This court set an expedited hearing for November 29, 2016. Other parties in interest filed opposition papers (dkt. 217-220) that pointed out flaws in the Business Plan and CPA Cash Flow Analysis. This court also independently reviewed those things. See, e.g., dkt. 285 (Tr. 11/29/16) p. 11:3-14.
At the hearing the Trustee noted that the debtor's future projections depended on an anticipated higher collection rate that had not been adequately supported:
The Trustee requested more time, to see if Dr. Sommer could back up his projections. Dr. Sommer opposed any additional time, arguing that this was an emergency both because of his own desperate need for cash and because he could not "ethically, morally and possibly from a malpractice standpoint, continue to generate billings
Dr. Sommer's counsel concluded:
One creditor favored "some funds going to Mr. Sommer for authorizing two new people," but subject to "tying additional resources to
Meanwhile, the Trustee opposed Dr. Sommer's Administrative Expense Motion, stating:
Despite this court's very serious concerns about Dr. Sommer's acts and failure to obtain authorization, this court granted temporary relief on both the Administrative Expense Motion and the Staffing Motion to preserve whatever value the debtor's operations might have. The Trustee was provisionally authorized to distribute up to $60,000 to Dr. Sommer on account of his alleged administrative claims, expressly reserving whether any final approval would be for a greater or lesser dollar amount. Dkt. 206. Meanwhile Dr. Sommer was authorized to interview but not hire additional staff.
The continued hearing on December 13, 2016 addressed multiple matters, including not only the Administrative Expense Motion and the Staffing Motion but also, in connection with a continued status conference, the issue of whether to convert the case from a chapter 11 reorganization to a chapter 7 liquidation. See dkt. 283 (Tr. 12/13/16) pp. 35:16-37:18 (discussing procedural basis to convert case at a status conference). The Trustee's papers included a detailed analysis of Dr. Sommer's purported administrative expenses and concluded that he was entitled to no more than $47,448.24. See dkt. 219, pp. 4:13-8:10 & pp. 10-13; and dkt. 295.
In the tentative ruling prior to the hearing (dkt. 224, Ex. A, part (1)(a)(i) of tentative ruling) this court reviewed various weaknesses in the debtor's Business Plan and the CPA Cash Flow Analysis and, more broadly, Dr. Sommer's arguments (id., part (1) passim). At that hearing counsel for Dr. Sommer reiterated:
This court responded:
Dr. Sommer's counsel did not point to any specific evidence in the record that would address how the debtor was going to generate sufficient
Dr. Sommer started by testifying that the patient retention that generated billing had gone up "dramatically." Dkt. 283 (Tr. 12/13/16) p. 24:1-13. This court asked Dr. Sommer to focus on "
Dr. Sommer did not directly address that issue. Rather, he testified that "we bill very soon" after obtaining "samples" (of patients' DNA), "and so [sic]
This court again asked Dr. Sommer to focus on providing some "assurance that the insurance companies are going to be
Instead he responded by confirming that it is difficult to know whether any particular genetic testing will or will not be helpful — which only reinforced this court's concerns that it may be difficult to predict whether insurers will
This court concluded:
The Trustee argued that, due to the debtor's inability to perform the testing to which Dr. Sommer had committed the debtor, and related problems, "This case needs to convert, and we need to close the business, and I intend to close the business tomorrow. I don't think there's any point, unless the Court tells me otherwise, to operate another day." Dkt. 283 (Tr. 12/13/16) p. 17:17-20.
This court did orally order conversion to chapter 7 (later memorialized in a written order), adding:
At the end of the hearing, Dr. Sommer requested that he be permitted to supplement his Administrative Expense Motion to provide additional documents, with a continuance so that this court could review those documents in camera. Even though the deadline for Dr. Sommer to provide his argument and evidence had passed prior to the hearing, this court granted that request and set a further continued hearing for January 17, 2017. See dkt. 283 (Tr. 12/13/16) pp. 41:14-46:4, p. 48:9-22, & p. 50:13-17, and dkt. 264 & 287.
In addition to further proceedings on the Administrative Expense Motion, this hearing involved a status conference and consideration of a proposed settlement which would have paid Dr. Sommer $50,000 for settling his claims against the estate and taking the debtor's medical records even though (i) it was not at all clear that he had allowable claims, or that the estate would be administratively solvent, and (ii) taking the medical records appeared to be a substantial benefit to him, not to mention his ethical and legal
As to the Administrative Expense Motion, this court ruled that, having considered the additional documents provided by Dr. Sommer, he still had failed to meet his burden to show that his expenditures were "actual" and "necessary" expenses of administration. Nevertheless, this court did allow him $47,488.24 out of the $144,238.31 that he requested because the Trustee had not opposed that reduced dollar amount (apparently because, giving Dr. Sommer the benefit of the doubt, he might have believed that the Trustee had authorized those expenditures and/or because the Trustee might have authorized those expenditures had he been asked, regardless whether in retrospect they actually were necessary or appropriate). See dkt. 285 (Tr. 11/29/16) pp. 19:13-21:14; dkt. 286 p.6:15-16.
On January 23, 2017 this court issued an order denying the remainder of the relief requested by the Administrative Expense Motion, and requiring a disgorgement of $12,551.76 of the $60,000 the trustee had already been authorized to distribute (dkt. 264). That order adopted this court's tentative ruling issued prior to the hearing, which stated in part:
After Dr. Sommer filed his motion for reconsideration of the Administrative Expense Order (the "Reconsideration Motion," dkt. 286), both Wells Fargo and the Trustee filed responses (dkt. 294 and 295). Pursuant to the usual procedures of the undersigned, the Reconsideration Motion was taken under submission.
The Reconsideration Motion is brought under Rules 59 and 60(b), made applicable by Rules 9023 and 9024. Dkt. 286, p. 2:8-10. As Dr. Sommer acknowledges, he must show that relief is justified by "mistake, inadvertence, surprise, or excusable neglect" or "any other reason justifying relief" or to "prevent injustice" or correct a "clear error of law or fact." Dkt. 286, MPA pp. 9:24-10:20 (PDF pp. 12-13) (citations omitted).
Dr. Sommer also cites Local Bankruptcy Rule 9013-4. This court does not interpret that rule as attempting to expand national Rules 59 and 60(b), and even if it did that would be impermissible. See In re Hung Tan Pham, 250 B.R. 93 (9th Cir. BAP 2000). In any event, even if the local rule were to establish any additional grounds for reconsideration, it would not change the following analysis.
Dr. Sommer asserts that this court had an "unjustified prejudice" against him and, more generally, he alleges "irregularity," "abuse of discretion," "insufficiency of evidence to justify decision," and "errors of law." Dkt. 286, MPA at p. 3 (PDF at p.6), lines 20-23 (tracking Local Rule 9013-4). Dr. Sommer claims that this court disregarded "
Dr. Sommer's Reconsideration Motion is most notable for what it does not do: it fails to point to any specific evidence in the record that would support his assertions. Instead he refers vaguely to
Even on the few occasions when the Reconsideration Motion alleges specific facts, it fails to cite to any part of the record that supports those allegations. For example, Dr. Sommer states in a footnote, "Collections for July 2016 were approximately $125,000" and "approximately $135,000" August of 2016," but there is no citation to any evidence supporting these numbers. Dkt. 286, n. 11, at p. 28:24-26. At another point he states, "As the Financial Data show, in the six months from July to December, more than $600,000 was received from insurance companies" while generating receivables of over $2.8 million (dkt. 299, p. 2:8-10 & p. 8:10-9:1); but again he fails to cite any evidence in the record.
There are over 300 filed documents on the docket of this case (plus more documents in the adversary proceeding). The "Financial Data" consist of dozens of (unspecified) documents on that docket, amounting to hundreds of pages.
Dr. Sommer's attempt to place the burden on other parties and this court to hunt through the record is rejected. It is
Dr. Sommer has the burden to show that his expenditures were "necessary" costs of preserving the bankruptcy estate, notwithstanding the Trustee's business judgment to the contrary. In addition, he must show a clear error of law or fact, or other grounds for reconsideration.
When Dr. Sommer filed his Administrative Expense Motion this court extensively reviewed the record, and concluded that Dr. Sommer has not carried his burden. He still has not carried that burden now, in his Reconsideration Motion. If anything, the record shows that he caused substantial harm to the bankruptcy estate.
According to the Business Plan, the debtor's billing increased postpetition by 540%. Dkt. 192, Ex. B, pp. 6-7 of 14. Dr. Sommer touts this huge increase as if it were a good thing, but he ignores the fact that it greatly overcommitted the debtor.
True, signing up more patients would almost instantly increase billings because "we bill very soon" after obtaining "samples" of their DNA. Dkt. 283 (Tr. 12/13/16) pp. 25:18-26:2; and see dkt. 284 (Tr. 1/17/17) pp. 11:23-12:8. But the debtor was billing for work that it had not yet performed.
Dr. Sommer testified, "it should take about four to five months to do the testing" but as to "the patients that were ascertained in September, it's more than a year before it gets done, if everything continues [i.e., without more staffing]." Dkt. 283 (Tr. 12/13/16) pp. 25:18-26:2; and see also dkt. 299, p. 10:2-5. Meanwhile, the debtor would have already collected whatever it was able to collect for those services. See CPA Cash Flow Analysis, dkt. 191, Ex. C, Assumption D (at dkt. 191-3, PDF p. 12) (projecting future collections stretching for 6 month period after billing); and see also Business Plan, dkt. 192, pp. 3:17-4:1 and Ex. B, p. 9 of 14, top line.
This placed the debtor at a substantial risk of liability arising from its over-commitments. Dr. Sommer's own purported expert, Mr. D'Amato, concedes that without substantial increases in resources and staff the debtor was headed for "business failure because of the
In other words, far from benefitting the debtor, vastly increasing billings without being able to do the work exposed the debtor to potentially vast liability.
Dr. Sommer points to alleged success stories (e.g., dkt. 299, pp. 3:1-5:15). It is difficult to know if these really were successful outcomes. There is no verification by any third party with appropriate expertise.
But assuming without deciding that the debtor really did have some notable medical successes, there is still no information that would show how these individual stories are relevant for
In other words, Dr. Sommer has not made the link between individual medical stories and his assertion that his unauthorized expenditures were "necessary" to preserve this bankruptcy estate.
Dr. Sommer relies heavily on the Business Plan for the proposition that, if more resources and staff were provided, then the debtor would become profitable. But the Business Plan is a projection for the future based on
For example, it assumes a future collections rate of 33-40% of billings (dkt. 192, Ex. B, p. 6 of 14), which is higher than the debtor's historical collections of 27.5% or less in 2015. Dkt. 183 (Tr. 11/29/16), p. 2:8-9 & p. 6:4-11; dkt. 192, Ex. B (Business Plan), p. 9 of 14 (11 lines down from top) ("Revenue collected Post-Petition Billings" based on "
The Business Plan's projected range of 33-40% turned out to be overly optimistic. Revised projections from MED-Billing Solutions reduced the range to between 30% and 35% (dkt. 183, p. 2:11-12) and the CPA Cash Flow Analysis used an estimated 30%. Dkt. 191, Ex. C, Assumption "C" to cash flow projections (at dkt. 191-3, PDF p. 12). See also id. at dkt. 191-3, PDF p. 14 of 17. At best, as the Trustee has pointed out, the debtor's "billings and collections are sporadic and unpredictable." Dkt. 171, p. 3:1.
Almost no actual collections data is provided by Dr. Sommer, and what is provided is cherry-picked and misleading. For example, his initial arguments (dkt. 286, n. 11, at p. 28:24-26) focus on two months in which collections were over $100,000 (July and August of 2016) while disregarding the much lower collections for the following month and almost every other month on which his Business Plan was based. See Business Report, Ex. B, Appendix A, p. 29 (dkt. 192) (postpetition collections of only $132.60 for May 2016, $12,998.00 for June 2016, and $40,226.28 for September 2016, as well as low collections for six months prepetition).
His later arguments (dkt. 299, p. 2:8-10 & p. 8:10-9:1) point to the "six months from July to December" in which "more than $600,000 was received from insurance companies." But that averages collections of only about $100,000 per month ($600,000 ÷ 6 months = $100,000/mo.), and it actually compares poorly against the greatly increased $2.8 million in billings over that same period. If anything, $600,000 in collections over six months appears to be a
Moreover, assuming for the sake of discussion that the debtor could maintain a meaningful increase in its rate of collections in future, any benefit would be reduced if not eliminated by related expenses. The Business Plan acknowledges:
In other words, not only does the Business Plan
In addition, the Business Plan presumes a huge increase in staff to do the genetic testing, for two reasons. First, the debtor's staff were already overworked: "Dr. Sommer is working over 110hrs/wk which is not sustainable" and "Current Admin staff cannot sustain the increased workload," not just from billing but also from "operations [and] intake." Dkt. 192, Ex. B, p. 8 of 14. Second, a lot more resources and staff would be needed to handle "the huge number of patients" that Dr. Sommer had signed up. Dkt. 191, p. 17, n. 3. The amount of additional work is not specified, but if the debtor's billing accurately tracked its increased commitments then the amount of genetic testing would have to increase roughly 540% from prepetition levels, requiring a huge increase in resources and staff devoted to genetic testing. Dkt. 192, Ex. B, pp. 6-7 of 14; and dkt. 192-2 at PDF p. 11.
Historically the debtor lost money. So the burden is on Dr. Sommer to show why the debtor somehow will become profitable by increasing volume 540%. His premise seems to be, as the old joke puts it, "we'll make up in volume what we lose on each sale." See, e.g., https://forum.wordreference.com/threads/make-it-up-on-volume.2246666/(similar version) (last checked 6/24/17).
The CPA Cash Flow Analysis discloses that "[b]illing and revenue estimates are based on assumptions made by the Debtor and its personnel, specifically Dr. Steven Sommer," and the CPA "cannot verify the accuracy of these estimates." Dkt. 191, pp. 35-36, nn. 30 & 31. For example, the estimate of salaries and wages is based on Dr. Sommer's assumptions about the number of employees and their salaries, which are unspecified except that the headcount will need to increase over time from 6 to 47. See dkt. 191, Ex. C, p. 68 and "Reference"/"Assumption" F (at dkt. 191-3, PDF p. 12).
In sum, the CPA Cash Flow Analysis adds nothing because, just like the Business Plan, it is based on Dr. Sommer's assumptions. Those assumptions are unsupported.
(None of the foregoing discussion should be taken to denigrate in any way the work that was performed by the CPA or others. The point is, their work can only be as good as the information or assumptions supplied by Dr. Sommer.)
As this court stated in the tentative ruling prior to the December 13, 2016 hearing, courts have generally interpreted the "actual" and "necessary" requirement as a question of whether a transaction with the bankruptcy estate "directly and substantially benefitted the estate." Collier on Bankruptcy, ¶ 503.06 (16th ed. 2016); see also Microsoft Corp. v. DAK Indus., Inc., 853 F.2d 700, 706 (9th Cir. 1988). As set forth at greater length in this court's tentative rulings and in the parties' briefs, the statute's authorization to pay administrative expenses is to be construed narrowly and applied cautiously. See dkt. 219, pp. 2:17-4:10.
Dr. Sommer seeks $30,841.26 for "Operating Expenses." Dkt. 287, at PDF p. 2 (second column). He fails to explain how these alleged expenses "directly and substantially benefitted the estate" beyond what the Trustee has agreed to pay. For example, this category appears to include numerous payments to Google the purpose of which is unspecified. See, e.g., dkt. 287, at PDF p. 4 (listing payments of $225, $500, $401.81 to Google in May of 2016). Listing expenses without explaining them does not meet his burden to show a direct and substantial benefit to the estate.
Dr. Sommer also seeks $79,655.33 for salary advances, mostly in the first four months of this case, but continuing for seven months. Dkt. 287, at PDF p. 2 (second column). Again, he has failed to show that he "directly and substantially benefitted the estate" by these advances, which include overtime pay to handle the work to which Dr. Sommer overcommitted the debtor without authorization, and hiring employees that the Trustee told him not to hire.
Finally, Dr. Sommer seeks $29,900.29 for attending conferences, which helped him sign up more patients. Dkt. 287, at PDF p. 2 (first column). He has failed to show that signing up more patients benefitted the bankruptcy estate "directly and substantially." To the contrary, he appears to have greatly harmed the estate by overcommitting the debtor.
Dr. Sommer's other assertions — such as claiming "unjustified prejudice," "irregularity," and "abuse of discretion" — appear to be premised entirely on overlooking his repeated disregard of his fiduciary duties, the Trustee's instructions, and this court's directions, as set forth above. His arguments lack merit.
For the foregoing reasons, and the additional reasons stated by Wells Fargo and the Trustee (dkt. 294 and 295), this court is not persuaded to depart from the Administrative Expense Order. This court will issue a separate order that Dr. Sommer's Reconsideration Motion is DENIED.
