LAURIE SELBER SILVERSTEIN, Bankruptcy Judge.
This is the second opinion in this case, which began as an involuntary petition filed against Diamondhead Casino Corporation ("Diamondhead" or the "Company") by three stockholders/noteholders. Soon after the involuntary petition was filed, these petitioning creditors moved for the appointment of a chapter 7 trustee during the gap period. For the reasons set forth in the first opinion, that motion was denied after an evidentiary hearing.
Now, the Court is faced with the alleged debtor's motion to dismiss the involuntary petition ("Motion to Dismiss").
On August 6, 2015, David A. Cohen, Arnold J. Sussman, and F. Richard Stark (the "Original Petitioning Creditors") filed an involuntary petition against Diamondhead. On September 11, 15, and 17, respectively, Robert F. Skaff, David J. Towner, and DDM Holdings, LLC (collectively, and together with the Original Petitioning Creditors, the "Petitioning Creditors") joined the involuntary petition.
On August 28, 2015, Diamondhead filed the Motion to Dismiss. While that motion was pending, the Petitioning Creditors filed an emergency motion seeking the appointment of an interim trustee ("Trustee Motion"). Following a status conference, the parties agreed that the Court should hear the Motion to Dismiss after hearing the Trustee Motion. An evidentiary hearing on the Trustee Motion was held on October 16 and 20, 2015, and the Trustee Opinion issued denying the motion.
On September 17, 2015, the Petitioning Creditors filed their opposition to the Motion to Dismiss. An evidentiary hearing was held on January 15, 2016. At the hearing on the Motion to Dismiss, the alleged debtor presented the further live testimony of Ms. Deborah Vitale, Diamondhead's Chief Executive Officer. Additionally, the parties agreed to include in their post-hearing submissions, designations and counter-designations of deposition testimony. They also incorporated into the hearing on the Motion to Dismiss all the evidence presented in connection with the Trustee Motion.
On February 5, 2016, Diamondhead filed its post-hearing opening brief.
The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 1334 and 157(a) and (b)(1). A motion to dismiss an involuntary petition is a core proceeding pursuant to 28 U.S.C. §§ 157(b)(2)(A) and (O).
None of the additional evidence adduced on the Motion to Dismiss causes the Court to question the factual conclusions reached in the Trustee Opinion. Accordingly, except to briefly reset the stage, the Court will elaborate upon and make further factual findings necessary for this opinion, but will otherwise rely upon the factual findings in the Trustee Opinion, all of which are incorporated herein.
Prior to August of 2000, Diamondhead operated ship-based gambling operations primarily out of ports located in Florida. In August 2000, Diamondhead divested itself of its ship-based operations and began to focus on the development of a land-based casino resort in Diamondhead, Mississippi. Since 2000, it has had no operations. Aside from a small amount of cash, Diamondhead's only tangible asset is its wholly owned subsidiary, Mississippi Gaming Corporation, which owns 404 acres of undeveloped land off of Interstate 10 in Diamondhead Mississippi (the "Property"). Since 2000, Diamondhead has sought to develop the Property into a destination resort centered around a casino. However, Diamondhead has never and does not currently have the financial wherewithal to develop the Property. Instead, it will need to raise funds or find a joint venture partner to attain this goal.
In 2010, pursuant to a private placement memorandum, the Company completed two rounds of financing. Diamondhead raised $475,000 in March 2010 and another $475,000 in November 2010.
Notwithstanding the Company's failure to develop the Property or to pay the 2010 Notes when they matured in 2012, there is no evidence that, prior to 2015, any of the Petitioning Creditors, or other investors or lenders, initiated litigation against Diamondhead. In 2014, however, several significant events occurred that were seen as troubling by one or more of the Petitioning Creditors.
First, in June 2014, the Securities and Exchange Commission temporarily suspended trading of Diamondhead stock for failure to make required filings, and in September 2014, the stock was deregistered.
Second, the Company granted a lien on the Property (the "Executives Lien") to Ms. Vitale and certain board members up to an aggregate amount of $2 million in order to secure outstanding amounts owed to them for past services, as well as to secure future obligations.
Third, Diamondhead's board ratified the Company's lease of a townhome owned by Ms. Vitale that served as the Company's headquarters.
Fourth, Diamondhead refused certain Petitioning Creditors' requests to add any new members to the board. Diamondhead twice turned down Mr. Skaff's request to sit on the board, the last request being January 2015.
Fifth, the Petitioning Creditors lost faith in management. Four of the Petitioning Creditors testified that, over the years, Diamondhead, and in particular, Mr. Harrison, continually represented to them that a deal to develop the property with various significant players in the casino industry was on the horizon.
In 2015, litigation began.
On January 15, 2015, College Health and Investments, Ltd. ("College Health")
Consistent therewith, on February 11, 2015, Diamondhead filed a motion to dismiss the College Health lawsuit as moot, asserting that Diamondhead had tendered the relief requested by College Health.
Second, Judge Carpenter acknowledged Diamondhead's right of conversion under section 2.1 of the note, but found that right limited to the time period prior to maturity. In particular, he found that in section 4.6 of the note, Diamondhead waived "any and all defenses it may have in the future with respect to [its obligation to pay the principal and interest as of the Maturity Date], except to the extent that (a) this Note has been converted into Common Stock in accordance with [section 2] prior to the Maturity Date. . . ."
As College Health's lawsuit was not moot, Diamondhead's motion to dismiss was denied. Thereafter, on July 16, 2015, Diamondhead filed its Answer and Grounds of Defense.
Prior to January, 2015, Diamondhead had not held an annual stockholder meeting for approximately 7 years. On February 13, 2015, College Health filed a complaint pursuant to 8 Del.C. § 211(c) in the Court of Chancery of the State of Delaware seeking an order compelling Diamondhead to hold an annual meeting.
As the Court previously found, Mr. Skaff undertook a consent solicitation to remove and replace Diamondhead's incumbent board. The group retained a proxy service firm to solicit votes for its own slate, which included Mr. Skaff. Approximately 29.5 million votes were cast and the incumbent group prevailed. Mr. Skaff testified to concerns about the propriety of the election, but he did not challenge the results.
At the annual meeting, the stockholders also voted on the Company's proposal to increase the number of shares that could be issued and outstanding. The proposal was necessitated by the Company's 2014 round of financing (the "2014 Financing"). As described in the 2014 Private Placement Memorandum, the 2014 Financing was in three tranches of $1 million each. An increase in the amount of shares that could be issued and outstanding was a condition to access the third tranche. The 2014 financing was fully subscribed, but the Company did not receive the full $3 million because (i) the conditions to access to the second tranche were not met, and not all subscribers to that tranche agreed to the amendments permitting access to the funds; and (ii) the full amount of the third tranche was unavailable (and returned) because the referendum to increase issued and outstanding shares was defeated at the annual meeting.
On March 14, 2015, College Health commenced another lawsuit in the Court of Chancery, this time against Edson R. Arneault, Ms. Vitale, Mr. Harrison, Martin Blount and Benjamin Harrell. College Health alleges that the defendants, all of whom are or were on Diamondhead's board of directors, have breached their duties of disclosure, loyalty and care. Defendants deny the allegations.
As of December 31, 2015, Diamondhead's current debt was $7.65 million. The debt includes outstanding notes in the aggregate amount of $4.8 million; $1.6 million in accrued salary (primarily owed to Ms. Vitale); $460,000 in interest due on preferred stock; $220,000 in fees owed to directors; and miscellaneous obligations of $220,000.
As of December 31, 2015, Diamondhead's only asset of any consequence was its indirect ownership of the Property. The undisputed testimony is that the Property was appraised at $39,350,000 by CB Richard Ellis.
Each of the individual Petitioning Creditors is both a stockholder and a noteholder,
Diamondhead alleges that the aggregate amount due to the individual Petitioning Creditors on their 2010 Notes is $322,913, including interest to December 31, 2015.
Mr. Stark provided the most comprehensive explanation of why the involuntary petition was filed. He testified that at the time of the proxy contest in June 2015, it was not his intention to put Diamondhead into bankruptcy proceedings.
When asked how he came to sign the involuntary petition, Mr. Cohen stated: "Again, it was just a means to an end. I really don't care. All I know is when someone is kicking you in the neck, you kind of want to slap the foot away."
Mr. Sussman testified that he filed the involuntary petition to collect on his 2010 Note.
Mr. Skaff did not testify to his reasons for joining the involuntary petition, but he did testify as to his belief that a trustee needed to be appointed. He believes that current management has mismanaged the company and should be replaced by a trustee.
Mr. Towner joined the involuntary petition because he does not see any progress in the development of the Property.
DDM is a Florida limited liability company formed on September 11, 2015,
Mr. Giller testified that DDM's primary purpose is to collect on its claim, which includes participating in a very limited capacity in the bankruptcy proceeding.
Diamondhead attacks the filing of the petition on three basis: (i) the Petitioners' claims, all of which are based upon the 2010 Notes, are subject to a bona fide dispute; (ii) under the Third Circuit's decision in Forever Green, the petition was filed in bad faith; and (iii) abstention is warranted under section 305 of the Bankruptcy Code.
Section 303(h) provides that:
The Bankruptcy Code does not define a "bona fide dispute." The Third Circuit has held that a bona fide dispute exists if "there is a genuine issue of a material fact that bears upon the debtor's liability, or a meritorious contention as to the application of law to undisputed facts."
"The court's objective is to ascertain whether a dispute that is bona fide exists; the court is not to actually resolve the dispute."
For instance, in B.D.W. the Third Circuit determined that the alleged debtor had not presented a bona fide legal dispute regarding a claim that it was liable on the debt on an alter ego theory.
The petitioning creditor has the initial burden to establish a prima facie case that no bona fide dispute exists.
The Petitioning Creditors each assert that he holds a 2010 Note that has matured, and that Diamondhead is required to satisfy the balance of the notes with cash. The Petitioning Creditors submitted copies of their notes. They also presented a copy of the Superior Court Decision, in which the court held that Diamondhead had to pay cash pursuant to the matured, unconverted 2010 Note held by College Health/DDM.
The Petitioning Creditors argue that they have made a prima facie showing that no bona fide dispute exists because they "establish[ed] the existence of a contract obligating Diamondhead to repay the amount borrowed."
As it did in the Superior Court, Diamondhead argues that it is permitted to satisfy the balance of the 2010 Notes with Diamondhead common stock. Specifically, Diamondhead argues that, pursuant to section 2.1 of the 2010 Notes, Diamondhead is permitted, after the notes mature, to convert its obligation to pay cash to the Petitioning Creditors into an obligation to transfer stock. The Petitioning Creditors disagree with Diamondhead's interpretation. Diamondhead argues that this disagreement constitutes a bona fide legal dispute.
In support of this argument, Diamondhead presents a limited record. It offered no testimony or evidence to show that the parties to the 2010 Notes intended that section 2.1 of the notes should allow Diamondhead to convert the balance to stock after the maturity date. Diamondhead did, however, provide the Court with its Answer and Grounds of Defense, which was filed in the College Health Superior Court action. Diamondhead argues that the answer contains several affirmative defenses that are applicable to the Petitioning Creditors' claims.
As an initial matter, the parties disagree on whether the Superior Court Decision regarding Diamondhead's 12(b)(1) motion to dismiss should factor into this Court's bona fide dispute analysis. As previously discussed, College Health filed a complaint against Diamondhead for the unpaid principal and interest on its 2010 Note. Diamondhead filed a motion to dismiss the complaint under Superior Court Rule 12(b)(1) asserting that it had satisfied its obligations under the note by tendering Diamondhead common stock.
The Superior Court denied Diamondhead's 12(b)(1) motion to dismiss. In doing so it disagreed with Diamondhead's legal argument and found that, pursuant to the terms of the 2010 Note, after the note matured, Diamondhead had no right to convert the balance into stock. Diamondhead now asserts the same legal argument before this Court.
The Petitioning Creditors contend that the Court can use the Superior Court Decision to conclusively resolve its bona fide dispute analysis. That is, the Petitioning Creditors appear to argue that the Court should use the Superior Court Decision to either offensively preclude Diamondhead from reasserting its legal argument or to per se establish that the dispute is not bona fide. Conversely, Diamondhead argues that the Court should not use the Superior Court Decision to conclusively resolve the bona fide dispute analysis because the ruling is a "preliminary, non-final ruling."
The Court is not aware of any decisional law addressing this issue, and the parties cited none. It is not clear that applicable non-bankruptcy law would allow a creditor to use a non-final 12(b)(1) ruling offensively to preclude a debtor from raising a defense in an action outside of bankruptcy.
Diamondhead attempts to support its argument by introducing the Answer and Grounds of Defense filed after the Superior Court denied its motion to dismiss.
"[T]he existence of affirmative defenses may suggest that a bona fide dispute exists."
Diamondhead's Answer and Grounds of Defense contains nine affirmative defenses. In its submissions to this Court, Diamondhead does not explain how any or all of its affirmative defenses support its position that a bona fide dispute exists. Rather, it states in its opening brief that its answer contains "material defenses (several of which are applicable to all noteholders, including those in this action)."
Initially, four of the affirmative defenses are specific to College Health and the action before the Superior Court.
Diamondhead's fifth affirmative defense is that the noteholders assumed the risk that their notes "would have to be converted to Common Stock."
Diamondhead's remaining affirmative defenses each assert a different version of the same ultimate argument: that Diamondhead has a right under section 2.1 of the 2010 Notes to convert the balance of the notes to common stock after the notes mature.
Pursuant to the terms of the 2010 Notes, the notes are to be construed in accordance with Delaware law.
The first paragraph of each 2010 Note establishes Diamondhead's obligation to repay the borrowed funds, as follows:
When the note matures, therefore, Diamondhead is obligated to pay in cash the principal and interest owing unless, before the date of maturity, Diamondhead has exercised its right to convert the principal and interest due on the note. Diamondhead's right to convert is limited temporally to the time prior to maturity by virtue of the obligation it created.
Diamondhead argues that section 2.1 of the 2010 Notes gives it the right to convert the cash balance into stock after the note has matured.
Section 2.1 delineates the mechanics of Diamondhead's conversion right. It does not, however, state whether or not Diamondhead may exercise its conversion right after maturity. Diamondhead argues that if section 2.1 is read in isolation the Court might conclude that its conversion right has no temporal limitation because the section does not state such a limit. The Court, however, must consider the note holistically. As previously discussed, the 2010 Note does contain a temporal limit on Diamondhead's conversion right—it requires Diamondhead to exercise its conversion right prior to the maturity date. Because section 2.1 does not contain a provision that conflicts with or otherwise expands Diamondhead's obligation, the silence of section 2.1 on the issue does not control.
The conclusion that the Borrower's Right to Convert in subsection 2.1 does not grant Diamondhead a temporally unlimited right to convert the note is further supported by the Holder's Right to Convert, which is also contained in section 2.1. In relevant part, the Holder's Right to Convert states: "[t]he Holder shall have the right to convert the unpaid principal due under this Note into Common Stock of the Borrower at any time."
Diamondhead also argues that section 3.2 of the 2010 Note, a section entitled "Remedies Upon An Event of Default," demonstrates that its conversion right was not temporally limited.
This argument is ultimately resolved by the finding that Diamondhead does not have a right to convert the balance to stock after the 2010 Notes matured. Section 3.2 does not change that result.
After a review of the undisputed documentary record and Diamondhead's legal arguments, the Court is satisfied that Diamondhead has presented no "potentially meritorious legal argument." Based on this record, there is no bona fide dispute over whether Diamondhead owes the Petitioning Creditors cash on account of the 2010 Notes.
Diamondhead and the Petitioning Creditors also dispute whether Petitioning Creditor DDM is in fact a creditor of Diamondhead. DDM claims to be the assignee of a 2010 Note originally held by College Health. As discussed above, College Health previously sued Diamondhead in Superior Court to collect on that 2010 Note. During the pendency of the Superior Court action and after the beginning of this case, College Health allegedly assigned the 2010 Note to DDM.
Diamondhead does not dispute that the 2010 Note is valid and matured or that College Health agreed to assign the 2010 Note to DDM. Rather, Diamondhead argues that the assignment of the note was not effective because the assignment violated both the terms of the 2010 Note and the bankruptcy automatic stay.
In determining whether the Petitioning Creditors presented a prima facie case showing that DDM's claim is not subject to a bona fide dispute, the Court is specifically focusing on whether the Petitioning Creditors presented evidence showing that the assignment to DDM was valid or otherwise enforceable.
The starting point of this inquiry is section 4.3 of the 2010 Note, which governs the noteholder's assignment rights. That section provides:
Pursuant to the second sentence of this section, College Health may assign the note only if it obtains Diamondhead's prior written consent or if the assignee is both a College Health affiliate and an accredited investor. DDM did not present any evidence that Diamondhead had supplied prior written consent, and the only evidence regarding whether DDM is a College Health affiliate or an accredited investor is to the contrary.
Having no such evidence, the Petitioning Creditors initially allege that, "[a]t the express request of the Company's directors, College Health assigned its note, including its cause of action against the Company, to DDM. . . . As a result of the assignment, DDM holds the assigned cause of action and the right to collect upon the cause of action, and to the extent permitted, the note that was given by Diamondhead."
Initially, the Petitioning Creditors do not present any legal analysis to support such a theory. But, even more damning, the evidence that the Petitioning Creditors point to does not show that Diamondhead consented to the DDM assignment. The Petitioning Creditors first submitted a copy of an August 28, 2015 email sent from Sam Burstyn, the general partner of College Health, to Gregory Harrison. The pertinent part of the email states:
Mr. Burstyn testified that the purpose of this email was "[t]o confirm to the Chairman of the Company that at their request . . . I was divesting from the company . . . [a]nd I began the process."
The Petitioning Creditors also point to the testimony of Ms. Vitale, which confirms that Mr. Burstyn's involvement with Diamondhead was problematic:
Neither the email nor Mrs. Vitale's testimony show that Diamondhead directed Mr. Burstyn to assign or otherwise transfer the 2010 Note to DDM or any other entity. In fact, the evidence suggests that Diamondhead was concerned with Mr. Burstyn's control over Diamondhead stock, not necessarily his ability to hold a 2010 Note.
Alternatively, the Petitioning Creditors present two more cursory arguments. The first is that, "[d]ue to the Company's material breach of the College Health [2010 Note] . . . Diamondhead cannot enforce any of its provisions including any assignment restriction contained therein."
Initially, and as before, the Petitioning Creditors provide no analysis and cite no relevant law to support these arguments. The only argument presented is that by virtue of the Superior Court Decision, Diamondhead cannot, after it breached the note, enforce the 2010 Note's anti-assignment term. The Superior Court Decision, however, is not persuasive authority because the issue before the Superior Court was materially different from the present issue. Namely, the Superior Court examined whether, after Diamondhead breached a 2010 Note, it could affirmatively exercise a contractual option right. The issue here is not whether Diamondhead, as the breaching party, has the contractual right to take a certain action, but whether College Health has a contractual right to take a certain action—the assignment to DDM. The Petitioning Creditors appear to argue that when Diamondhead breached the 2010 Note, College Health's rights under the 2010 Note somehow improved. The Superior Court Decision does not, however, suggest that Diamondhead's breach modifies, let alone improves, the noteholder's contractual rights, and is thus inapposite here.
Further, the Petitioning Creditors also fail to support the factual assertion in their second argument—that College Health assigned to DDM its causes of action against Diamondhead (independent of the 2010 Note). While Mr. Burstyn did testify that he caused DDM to assign causes of action to College Health,
The Petitioning Creditors may have established a prima facie case that assignment occurred from College Health to DDM. The Petitioning Creditors' bald assertions and legal arguments, however, are insufficient to carry their initial burden to show that no bona fide dispute exists regarding that assignment.
In Forever Green, the Third Circuit held that a court may dismiss an involuntary petition for bad faith even when the petitioning creditors otherwise meet the statutory criteria. The Court reasoned that a bankruptcy petition—whether voluntary or involuntary, and whether under chapter 11 or 7—commences an equitable proceeding.
In addition to holding that an involuntary petition may be dismissed for bad faith, the Third Circuit examined the "dizzying array" of standards employed by courts when making this determination and settled on the "totality of the circumstances" test. As the Third Circuit explained: this standard "is most suitable for evaluating the myriad ways in which creditors filing an involuntary petition could act in bad faith."
The totality of the circumstances test is an amalgam of tests used by other courts, including: (i) the "improper use" test, which reviews whether the petitioning creditors are seeking to obtain a "disproportionate advantage" over other creditors; (ii) the "improper purpose" test, which looks to the motivation of the petitioning creditors (i.e., whether the filing "was motivated by ill will, malice or a desire to embarrass or harass the alleged debtor"); and (iii) the "objective test" which gauges what a "reasonable person" would have done in the petitioning creditors' position.
The burden of persuasion is on the alleged debtor, which must prove by a preponderance of the evidence that the petition was filed in bad faith.
Diamondhead argues that the original Petitioning Creditors as well as the subsequent joining creditors filed the involuntary petition to oust management after they lost a proxy contest just two months earlier. It argues that the testimony shows that the Petitioning Creditors' motivation was to remove management, and that, in their haste, they did not make a reasonable inquiry into the facts and pertinent law before filing the involuntary petition. Diamondhead further argues that joining Petitioner Skaff worked with Mr. Stark to orchestrate the proxy contest, and that Mr. Towner joined the petition because he works for Mr. Skaff. Diamondhead next argues that the involuntary petition does not serve a valid bankruptcy purpose because a bankruptcy does not maximize Diamondhead's assets. Diamondhead sees risk in the bankruptcy filing and the potential devaluation of the Property. Further, Diamondhead claims it is not preferring one creditor over others, but rather not paying anyone. Finally, Diamondhead argues that the involuntary petition was filed in bad faith because the bankruptcy court is not a substitute for a collection action; Petitioning Creditors can proceed in state court to recover their debts.
The Petitioning Creditors argue that Diamondhead has failed to meet its burden of proof to show that the involuntary petition was filed in bad faith. They argue that the vast majority, if not all, of the Forever Green factors weigh in favor of entering the order for relief. Specifically, they argue that they are qualifying creditors, the debtors are not generally paying their debts as they come due, and the 2010 Notes are due and payable. At various places in their brief they argue that they filed the involuntary petition to: (i) avoid the Executives Lien granted to Ms. Vitale and the board members; (ii) seek the appointment of an independent fiduciary to investigate and pursue breach of fiduciary duty claims against Diamondhead's officers and directors going back 15 years; (iii) analyze and assume or reject any executory contracts that may exist; (iv) secure the Company's books and records; and (v) maximize the value of the Company's assets through a fair and open sale process.
Having just ruled that the individual Petitioning Creditors hold bona fide debts that remain unpaid, the Court will discuss certain of the other Forever Green factors as it evaluates the totality of the circumstances. As presaged in the Trustee Decision, and as will be discussed below, certain of the Forever Green factors weigh in favor of dismissal and certain do not. The challenge, therefore, is to look at the totality of the circumstances and determine whether the alleged debtor has proven by a preponderance of the evidence that the filing was in bad faith. If not, the Court should enter an order for relief.
In the Trustee Decision, the Court held that Diamondhead was generally not paying its debts as they become due because it was not paying Ms. Vitale's salary or rent as it lacked the funds to do so. Diamondhead presented no new evidence on this issue at the hearing on the Motion to Dismiss and does not appear to challenge the Court's finding. Accordingly, the Court finds that the individual Petitioning Creditors satisfied the statutory criterial for filing the petition.
But, for what purpose was the bankruptcy petition filed? The situation before the Court is somewhat unique in that each individual Petitioning Creditor wears two hats—that of a noteholder and that of a stockholder. Only creditors can file an involuntary petition, not stockholders. Stockholders in a Delaware corporation have a myriad of state law rights designed to protect their equity interests. For example, stockholders can bring an action to inspect the books and records of a company for any proper purpose, to compel an annual meeting, and to determine the validity of any election at an annual meeting.
While contending otherwise, the evidence is overwhelming that each individual Petitioning Creditor sought a change in management, and perceived an involuntary bankruptcy filing as the only way to accomplish that result after the failed proxy fight. Each of the Original Petitioning Creditors has held their stock for at least fifteen years. Each individual Petitioning Creditors expressed his frustration with the lack of development of the Property, not the non-payment of their notes. Each individual Petitioning Creditor testified that he had been misled by Mr. Harrison regarding the possibility of a development deal, and one testified that he had retained his investment at Mr. Harrison's urging. Each had lost faith in Ms. Vitale and/or Mr. Harrison, and each individual Petitioning Creditor no longer believed that any deal to develop a casino on the Property was imminent. Indeed, each individual Petitioning Creditor believes that Diamondhead's current management is incapable of making a deal, hence the desire for "an independent fiduciary in this bankruptcy proceeding [] empowered to look at proposals for the sale or development of the Property and decide what is in the best interests of the Company and all stakeholders." Accepting all of these grievances as true, which the Court does, these are the grievances of a stockholder who disagrees with management's decisions. As Mr. Stark, the apparent leader of the original Petitioning Creditors, candidly testified: had the opposition slate won the proxy contest, he would not have filed the involuntary petition. This testimony was not contradicted by any of the other Petitioning Creditors.
Not surprisingly, a petitioning creditor's desire to change management because it disagrees with the direction they are taking (or not taking), is not the subject of many bankruptcy decisions. As the Petitioning Creditors note, the few cases cited by Diamondhead for the proposition that dismissal is appropriate when a petitioning creditor is seeking to resolve intra-company management and stockholder disputes are distinguishable on their facts. These cases are essentially two party disputes, or disputes among partners or equity holders in closely held companies, often when the company is paying its debts as they become due.
In their post-hearing submission, the Petitioning Creditors insist that they filed the involuntary petition to protect the Property, preserve an avoidance action, and prevent any other liens from being placed on the Property so as to "forestall any further dissipation of assets from reaching bona fide existing creditors."
Diamondhead correctly argues that neither placing an Executives Lien on the Property nor payment of legitimate debts (including, Diamondhead asserts, legitimate salary and rent to Ms. Vitale) is dissipation of assets, another Petitioning Creditor complaint. And, looking beyond counsel's argument and briefing, the record contains little support for the argument that avoiding the Executives Lien, as opposed to frustration at the insider nature of the transaction, was a motivating factor for the filing of the involuntary petition. But the concern about preferential treatment, if correct, is a legitimate concern, and standing alone would be a proper purpose for the filing of an involuntary proceeding.
The Petitioning Creditors offer no analysis of the potential avoidance of the Executives Lien, stating simply that "the Lien is an avoidable transfer for which no good faith defense is available."
Second, it is far from certain that Diamondhead was insolvent on September 26, 2014—another requisite for a preferential transfer.
Neither Diamondhead nor the Petitioning Creditors adduced evidence with respect to the solvency or insolvency of Diamondhead as of September 26, 2014. But, the Petitioning Creditors did submit into evidence Friedman LLP's Report of Independent Registered Public Accounting Firm dated March 31, 2015.
There was no testimony regarding market valuation of the Property as of September 26, 2014. At the Motion to Dismiss Hearing, Ms. Vitale testified that as of December 31, 2015, the value of the undeveloped Property was $39,350,000 based on the appraisal performed by CBRE. CRBE's valuation was as of January 26, 2015 only four months after the recording of the Land Deed of Trust.
The Petitioning Creditors assert that the Court should give no credit to Ms. Vitale's testimony,
Finally, given the lack of operations, the lack of cash, and the auditors' doubts that the Company could remain a going concern in 2010, no reasonable person would have invested money in this Company if he believed that the Property was worth no more than its book value.
Thus, even if the Court were to discount Ms. Vitale's undisputed testimony, based on the totality of the evidence presented, the Court finds that a trustee would have significant hurdles in proving insolvency as of September 26, 2014.
The Petitioning Creditors also deny that the involuntary petition was a substitute for customary debt collection and assert that the timing was based on the Superior Court Decision, not the failed proxy contest, and thus not "suspiciously timed."
Here, each of the Original Petitioning Creditors testified that the filing of the bankruptcy was an attempt, directly or indirectly, to collect on their promissory notes. And, Mr. Towner and DDM concurred. As this Court has previously recognized, involuntary bankruptcy proceedings are not to be used as a collection device.
As to the timing of the involuntary filing, not one of the Petitioning Creditors testified that the timing of the filing was based on the issuance of the Superior Court Decision. Rather, as Mr. Stark explained, the idea came about "subsequent to the [annual stockholder] meeting when we saw that it was hopeless for this company to move forward with its present leadership and board."
The Petitioning Creditors also deny any ill-will towards Diamondhead, Ms. Vitale or Mr. Harrison. While the Court did not have the benefit of observing the demeanor of the Petitioning Creditors other than Mr. Sussman and Mr. Skaff, the level of frustration with current management jumps off the deposition page. Frustration, however, is not necessarily ill-will, and the Court cannot attribute to the Petitioning Creditors any ill-will toward Diamondhead, Ms. Vitale or Mr. Harrison. On the other hand, Mr. Burstyn clearly holds ill-will towards Ms. Vitale, but he is not a Petitioning Creditor. And, even if the Court can attribute his sentiments to DDM, the Court cannot attribute his sentiments to the other Petitioning Creditors.
Neither does the Court find that this case was used to obtain a tactical advantage in pending litigation. The filing certainly does not advantage College Health/DDM's case on its 2010 Note as it stayed this litigation in which College Health won an early victory. Nor does Diamondhead argue that the filing of the involuntary petition gives College Health a tactical advantage in its breach of fiduciary duty case pending in Chancery Court.
Further, the Court does not find, and Diamondhead does not argue, that the filing of the involuntary case was an attempt by the Petitioning Creditors to obtain a disproportionate advantage over other creditors. But, the Court does find that the filing was an attempt by the Petitioning Creditors to obtain a disproportionate advantage over other stockholders. On June 8, 2015, the Company held an annual meeting of stockholders at which directors were elected. At that meeting, the majority of stockholders voted to approve Diamondhead's incumbent slate of directors thereby defeating the opposition slate advanced by Mr. Skaff and/or Mr. Stark. Though Mr. Skaff expressed concerns about the propriety of the election, neither he nor any other party took advantage of Section 225 of the Delaware General Corporation Law to contest the election. In filing the involuntary petition to effect a change in management, the Petitioning Creditors sought to upend the results of the stockholder vote, which occurred just two months earlier. The Court concludes that this is analogous to an attempt by a creditor to gain an advantage over another creditor.
Having reviewed the record, the Court finds that Diamondhead has met its burden to show that the involuntary petition was filed in bad faith. While some of the evidence points in the other direction, the testimony and the Petitioning Creditors' Answering Brief were replete with stockholder concerns. Based on the totality of the circumstances, the Court finds that the Petitioning Creditors' primary concern in filing the involuntary petition was to effect a change in management to benefit their investments as stockholders. The Court finds this not to be a proper purpose for filing an involuntary bankruptcy petition. A secondary concern was to collect on their notes. While it may be proper in some circumstances for noteholders to band together to file an involuntary bankruptcy petition, it is not appropriate here, where the noteholders are looking to vindicate their equity interests and where myriad state law remedies are available. Finally, to the extent that there is any evidence to support the notion that the Petitioning Creditors' motivation in filing the involuntary was to avoid the Executives Lien, that motivation was tertiary, at best, and likely ill-conceived.
The Court understands and fully appreciates the Petitioning Creditors' frustration with the lack of progress over the last fifteen years with respect to the development of the Property. The Court also understands and fully recognizes that Diamondhead may not be successful in either resolving the disputes with the Petitioning Creditors or in raising funds to pay off the 2010 Notes. And, the Court cannot rule out the possibility of a voluntary bankruptcy in Diamondhead's future; but, that is not before the Court.
For the foregoing reasons, Diamondhead's motion to dismiss or alternatively to abstain is GRANTED.
Cohen Dep. 17-18.
Cohen Dep. 21-23.
