DONALD R. CASSLING, Bankruptcy Judge.
When the owner of a Chapter 11 debtor is also the chief customer of that debtor, does the owner's dual role automatically constitute "cause" for appointing a Chapter 11 trustee under 11 U.S.C. § 1104(a)(1)? The Debtor's largest secured creditor, Wells Fargo Bank, N.A., urges this Court to answer that question in the affirmative. Wells Fargo also insists that even if the Court's answer is no, the owner should still be replaced with a Chapter 11 trustee because the owner has allegedly (1) proven itself incompetent to operate or reorganize the debtor, (2) flouted the orders of this Court, and (3) forfeited the trust and confidence of Wells Fargo. For the reasons that follow, the Court rejects Wells Fargo's primary argument both as a general legal proposition and under the particular facts of this case. In addition, the Court finds that Wells Fargo failed to establish by clear and convincing evidence that there either is "cause" to appoint a Chapter 11 trustee under § 1104(a)(1) or that it is in the interests of all creditors, equity security holders, and other interests of the estate to appoint a trustee under § 1104(a)(2).
The Court has jurisdiction to entertain this matter pursuant to 28 U.S.C. § 1334 and Internal Operating Procedure 15(a) of the United States District Court for the Northern District of Illinois. It is a core proceeding under 28 U.S.C. § 157(b)(2)(A) and (O).
LHC, LLC (the "Debtor") was formed as an Illinois limited liability company on November 8, 2006. The Debtor is a not-for-profit enterprise that owns and operates a three-sheet ice-skating rink in West Dundee, Illinois, known as the "Leafs Ice Centre" (the "Rink"). The Rink sells ice time to various skating organizations in Illinois as well as to the general public. The sole member of the Debtor and largest customer of the Rink is the Leafs Hockey Club (the "Club"), an amateur hockey organization. Although the Debtor is a taxable limited liability company, its income is passed through to the Club. The Club does not pay tax on the income received from the Debtor because the Debtor is a non-profit company. The Debtor owes $20 million to bondholders represented by Wells Fargo, the indenture trustee for the bondholders. The Club has guaranteed repayment of that debt.
Wells Fargo argues that under § 1104(a)(1) the Court is required as a matter of law to appoint a Chapter 11 trustee where the Club is both owner and customer of the Debtor, because it must be presumed as a matter of law that the Club will always elevate its interests as customer over its interests as owner of the Debtor. In support of this argument, Wells Fargo proffered the expert testimony of Edward B. Cordes, a CPA and certified fraud examiner. Mr. Cordes opined that the Club's economic self-interest requires it always and invariably to advance its own economic interests at the expense of the Debtor, its creditors and its other customers. In response, the Debtor argues that the conflict of interest issue is not a purely legal issue. According to the Debtor, the facts show the Club's interests are consistent with those of the Debtor, and the Debtor has therefore acted in the best interests of its creditors and customers,
Independent of its conflict-of-interest argument, Wells Fargo argues that cause exists for a number of other reasons to appoint a Chapter 11 trustee under § 1104(a)(1). Specifically, Wells Fargo alleges that the Debtor: (1) failed to maintain proper accounting records; (2) improperly purchased goods and services on the eve of bankruptcy, rather than waiting to do so under the auspices of the bankruptcy court; and (3) violated the terms of certain cash collateral orders. Finally, Wells Fargo argues that it would be in the interests of creditors, equity security holders, and other interests of the estate to appoint a trustee under § 1104(a)(2) because the Debtor's inherent conflict of interest with the Club, its managerial incompetence, its failure to communicate, and its lack of transparency have all caused Wells Fargo to lose confidence in the Debtor's ability to operate and reorganize.
The Debtor responds that it was forced to recreate its books and records from scratch when its former management company was replaced and refused to turn over the accounting records it had maintained theretofore. The Debtor states that it has now successfully recreated those records and instituted internal controls that will ensure that the records will be complete and accurate as this case progresses. The Debtor justifies its pre-petition purchases of goods and services as being necessary for health and safety reasons as well as for the Debtor's future financial welfare. The Debtor argues that it has complied with the cash collateral orders and that Wells Fargo's arguments to the contrary are based upon a misinterpretation of the terms of those orders. Finally, the Debtor states, given Mr. Cordes's complete access to and constant monitoring of its records and activities on Wells Fargo's behalf, Wells Fargo can hardly complain of a lack of transparency or communication.
For the reasons that follow, the Court concludes that Wells Fargo failed to establish by clear and convincing evidence that a Chapter 11 trustee should be appointed under either § 1104(a)(1) or (a)(2).
The Debtor has a five-member board of managers,
The money needed to acquire the land for the Rink and to build and equip it was financed by $20 million in Sports Facility Revenue Bonds Series 2007A Taxable Series 2007B (the "Bonds") issued on February 1, 2007 by the Illinois Finance Authority (the "Authority"). Proceeds of the
The Club guaranteed payment of the principal and interest on the Bonds pursuant to a guaranty agreement dated February 1, 2007. The Bonds are also secured by a mortgage, assignment of leases and rents, security agreement and fixture filing, all dated February 1, 2007. The Amalgamated Bank of Chicago was the original trustee (the "Original Trustee") until it was replaced by Wells Fargo on August 9, 2009. Pursuant to the indenture, the Authority pledged and assigned to the Original Trustee, as security for the Bonds, all of the Authority's right, title, and interest in and to, inter alia, the amounts payable under the indenture and loan agreement (excluding certain unassigned rights) and all amounts payable in respect to the indebtedness evidenced by the loan agreement and the indenture.
On December 11, 2012, the Club replaced the entire board, of managers of the Debtor. The board positions of Michael Durkin (director/president), John Willet (director/treasurer), Don LaPato (director), Terry Nolan (director/secretary), and Danielle Gulli (director) were all terminated. The new Board consisted of five Club members: (1) Peter Buh (director/president); (2) Steve Goluch (director/CFO); (3) Michael Greco (director); (4) RJ Grewal (director/secretary); and (5) Ed McHale. At the time of filing, RJ Grewal was the secretary of the Club, and the interim operations representative for the Debtor. He has since been elected to serve as the president of the Club.
On December 28, 2012, shortly after the board of managers was replaced, Wells Fargo filed a foreclosure proceeding against the Debtor in the Circuit Court of the Sixteenth Judicial Circuit, Kane County, Illinois.
While the foreclosure proceeding was pending, the Debtor's new board of managers decided that the Debtor needed to take dramatic action to reverse its poor financial condition:
First, on February 4, 2013, it replaced Club Sports Consulting Group, Inc. ("CSCG") the professional management company that previously operated the Rink and replaced it with Fairview Facilities Management, LLC ("Fairview") pursuant to the terms of a professional management
Paul O'Dacre is an employee of Fairview, the current general manager of the Rink, and he has extensive experience managing ice rinks. Mr. O'Dacre testified that when he became the general manager on February 4, 2013, the Rink was in disrepair. His testimony as outlined below was unrefuted by Wells Fargo and is therefore accepted by the Court as an accurate representation of the conditions at the Rink when Mr. O'Dacre and Fairview assumed responsibility for its operation:
In the period shortly preceding the Debtor's bankruptcy petition, the Debtor made a number of capital expenditures designed to correct some of the more serious problems noted by Mr. O'Dacre. These purchases and expenditures included: (1) a scissor lift; (2) new lighting for the Rink; (3) modifications to the security cameras; (4) the purchase of new office furniture; (5) the purchase of two arcade games; (6) upgrades to the concessions computer system; (7) repairs to the cooling tower; (8) repairs to the boards and glass surrounding the arenas; (9) paying for extra employees not employed by the Debtor;
In his testimony, RJ Grewal, the interim operations representative of the Debtor and the president of the Club, gave two explanations in response to Wells Fargo's assertion that the Debtor should have waited until filing for bankruptcy to incur these expenses. First, he testified that the Debtor did not know until February 25, 2013, that it would be filing for bankruptcy. Until that date, it had been working with Wells Fargo on a forbearance agreement. Wells Fargo offered no evidence to the contrary and the Court accepts Mr. Grewal's testimony that the Debtor made the expenditures in response to Mr. O'Dacre's analysis of what the Rink needed in order to operate safely and efficiently, and not in anticipation of bankruptcy.
Second, Mr. Grewal testified that the Rink's defects identified in Mr. O'Dacre's testimony were so serious that it was prudent for the Debtor to make the following capital expenditures:
On February 25, 2013, prior to the scheduled hearing to appoint a receiver in the foreclosure proceeding, the Debtor filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code (the "Petition Date"). The Debtor has since been operating its business and managing its financial affairs as a debtor-in-possession. No trustee or examiner has been appointed to serve in the Debtor's bankruptcy case.
On March 29, 2013, Wells Fargo filed its motion to appoint a trustee under § 1104(a).
The moving party has the burden of proving grounds that justify the appointment of a Chapter 11 trustee and, in doing so, must overcome a strong presumption that the debtor is to remain in possession. In re Madison Mgmt. Grp., Inc., 137 B.R. 275, 281 (Bankr.N.D.Ill. 1992). Neither the United States Supreme Court nor the Seventh Circuit Court of Appeals has determined the appropriate burden of proof for appointment of a Chapter 11 trustee. Several bankruptcy courts in this district have applied the clear and convincing standard. Raymond Prof'l Grp., Inc. v. William A. Pope Co. (In re Raymond Prof'l Grp., Inc.), 421 B.R. 891, 909 (Bankr.N.D.Ill.2009); In re Bellevue Place Assocs., 171 B.R. 615, 623 (Bankr.N.D.Ill.1994), aff'd., Nos. 94 C 5089, 94 C 5090, 94 C 5091, 1994 WL 687474 (N.D.Ill. Dec. 8, 1994); Madison Mgmt., 137 B.R. at 281; In re Sanders, Bankr.No. 99 B 9876, 2000 WL 329574, at *3 (Bankr.N.D.Ill. Mar. 2, 2000).
Applying the clear and convincing evidence standard appears to the Court to be more consistent with the presumptions that a debtor should generally be permitted to remain in control and possession of its business and that the appointment of a Chapter 11 trustee is an extraordinary remedy. See In re Berwick Black Cattle Co., 405 B.R. 907, 912 (Bankr.C.D.Ill.2009). In light of those presumptions, the lack of direction from either the Supreme Court or the Seventh Circuit, and the split in authority among the circuits, the Court will apply the higher standard of proof — clear and convincing evidence.
Appointment of a trustee is a fact-sensitive determination that must be made on a case-by-case basis. In re 4 C Solutions, Inc., 289 B.R. 354, 370 (Bankr. C.D.Ill.2003). In making this determination, the court may examine both pre- and post-petition conduct. Oklahoma Refining Co. v. Blaik (In re Oklahoma Refining Co.), 838 F.2d 1133, 1136 (10th Cir.1988). A determination of whether "cause" exists to appoint a trustee "is within the discretion of the court and due consideration must be given to the various interests involved in the bankruptcy proceeding." Bellevue Place, 171 B.R. at 623.
Section 1104(a) of the Bankruptcy Code provides the statutory basis for the appointment of a trustee in a Chapter 11 case:
11 U.S.C. § 1104(a).
A court "shall" appoint a Chapter 11 trustee if it determines that there is "cause" to do so under § 1104(a). Unfortunately, that section does not define "cause," but instead offers a non-exhaustive list of conditions that may each establish "cause" to appoint a trustee: fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management. Ontario Entm't Corp. v. Chicago Title & Trust Co. (In re Ontario Entm't Corp.), 237 B.R. 460, 472 (Bankr.N.D.Ill.1999). In examining whether a particular set of circumstances amounts to "cause" under § 1104(a)(1), courts may also take into account whether: (1) the alleged misconduct was material; (2) the debtor treated insiders and affiliated entities better or worse than other creditors or customers; (3) the debtor made pre-petition voidable preferences or fraudulent transfers; (4) the debtor was unwilling or unable to pursue causes of action belonging to the estate; (5) conflicts of interest on the part of management interfered with its ability to fulfill its fiduciary duties to the debtor; and (6) management engaged in self-dealing or squandering of corporate assets. In re Intercat, Inc., 247 B.R. 911, 921 (Bankr.S.D.Ga. 2000).
Courts have found the existence of "cause" under a variety of circumstances. For example, cause was established where a debtor-in-possession failed to keep adequate records, failed to file reports, and engaged in a history of questionable transactions with affiliated companies. See Oklahoma Refining, 838 F.2d at 1136 ("There are many cases holding that a history of transactions with companies affiliated with the debtor company is sufficient cause for the appointment of a trustee where the best interests of the creditors require."). Cause, in the form of an irreconcilable conflict of interest, was found when a debtor-in-possession had an interest in a company attempting to acquire technology of the debtor and had engaged in self-dealing. See In re Embrace Sys. Corp., 178 B.R. 112, 128-29 (Bankr.W.D.Mich.1995); see also In re L.S. Good & Co., 8 B.R. 312, 315 (Bankr.N.D.W.Va.1980) (finding that conflicts of interest and remote prospects for rehabilitation constituted cause for appointment of a trustee). In addition, because debtors-in-possession are fiduciaries of the estate, a breach of their fiduciary duties may constitute cause. See In re Russell, 60 B.R. 42, 47-48 (Bankr. W.D.Ark.1985).
Finally, although courts are directed to appoint a trustee once "cause" has been established, the determination of whether cause has been established is solely within the discretion of the court. In re Sharon Steel Corp., 871 F.2d 1217, 1226 (3d Cir.1989).
Even where § 1104(a)(1) cause has not been established, a court may appoint a trustee if it determines that such appointment is "in the interests of creditors, any equity security holders, and other interests of the estate, without regard to the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor." 11 U.S.C. § 1104(a)(2). The case law interpreting § 1104(a) has concluded that the appointment standards are more flexible under subsection (a)(2) than under subsection (a)(1). Tradex, 339 B.R. at 829; Bellevue Place, 171 B.R. at 623.
Determining whether appointment of a trustee is in the interests of the various constituencies of the estate is fact-specific and requires the court to balance the benefits of such an appointment against its anticipated costs. See Sanders, 2000 WL 329574, at *5. The factors that have been considered include: (1) the trustworthiness of the debtor; (2) the debtor's past and present performance and prospects for rehabilitation; (3) whether the business community and creditors of the estate have confidence in the debtor; and (4) whether the benefits outweigh the costs. Madison Mgmt., 137 B.R. at 282. Appointment of a trustee under § 1104(a)(2) is within the sound discretion of the bankruptcy judge. Tradex, 339 B.R. at 829; Bellevue Place, 171 B.R. at 623.
Wells Fargo argues that "cause" exists under § 1104(a)(1) to appoint a trustee because there is an irresolvable conflict of interest between the Club and the Debtor. The legal principles underlying its argument are straightforward: The debtor-in-possession serves in a fiduciary capacity with fiduciary duties to all of its creditors. Sanders, 2000 WL 329574, at *4; Bellevue Place, 171 B.R. at 623. This obligation includes a duty of care, a duty of loyalty, and a duty of impartiality. In re Eurospark Indus., Inc., 424 B.R. 621, 627 (Bankr.E.D.N.Y.2010); In re Bowman, 181 B.R. 836, 843 (Bankr.D.Md.1995); Bellevue, 171 B.R. at 624. "The duties to avoid self-dealing, conflicts of interest and the appearance of impropriety are encompassed in the concept of duty of loyalty." Bowman, 181 B.R. at 843. If the debtor clearly appears incapable of discharging those duties, appointment of a trustee is not only warranted but required. Sanders, 2000 WL 329574, at *5; In re Nautilus of New Mexico, Inc., 83 B.R. 784, 789 (Bankr.D.N.M.1988).
Wells Fargo argues that the following allegations mandate appointment of a trustee under those legal principles: (1) the Debtor is the landlord of the Club; (2) the Debtor's board of managers consists entirely of members of the Club; (3) the Debtor offered lower ice rental rates and preferential ice time to the Club; (4) there is no formal written ice rental agreement between the Debtor and the Club, and the Debtor stretched out the Club's payments; and (5) an executive of the Club participated in the negotiations of ice rental agreements with the Debtor's other customers. The Court addresses each of these allegations in turn.
Wells Fargo first argues that a conflict of interest arises because the Debtor, the
The factual premise for Wells Fargo's argument is false because Wells Fargo has failed to establish that there is a landlord/tenant relationship between the Debtor and the Club. The Club is merely a customer of the Rink and pays for services that include partial use of the Debtor's ice, to be shared with the other customers of the Rink. The relationship between the Debtor and the Club could more properly be described as that of a licensee and a property owner much like the relationship of a bowling league to a bowling alley whose lanes it uses one night a week. However one characterizes the relationship between the Debtor and the Club, it is not a landlord/tenant relationship of the type involved in the SunCruz Casinos case. In addition, Wells Fargo's landlord/tenant analogy overlooks another crucial relationship between the Debtor and the Club, that of debtor/guarantor. Because the Club is a guarantor of the Debtor's bond debt, there is a unity of interests that would ordinarily be absent from a tenant/landlord relationship.
The landlord/tenant analysis fails for other reasons, as well. There is no written lease agreement between the Club and the Debtor or, indeed, between the Debtor and any of its other customers. (See Ex. No. 5.) The Debtor has a formal written agreement for ice time with Team Illinois, its second largest customer.
Because the Court rejects Wells Fargo's characterization of the Club's relationship with the Debtor as that between a tenant and a landlord, Wells Fargo's reliance upon SunCruz Casinos is misplaced. However, even if the Court were to find that such a relationship existed, Wells Fargo misstates the holding in that case. SunCruz Casinos stands for the proposition that if the debtor is a tenant and the debtor's sole owner is its landlord, this is one factor, among many, that will be weighed when deciding to appoint a Chapter 11 trustee. Id. at 830-32.
Finally, SunCruz Casinos is distinguishable on its facts.
The Court also finds unpersuasive Wells Fargo's argument that cause exists to appoint a trustee because the Debtor's board of managers consists entirely of Club members. It is undisputed that the Club is the sole entity in control of the Rink. However, that fact alone is not sufficient to prove that there is a conflict between their positions. Instead, the facts established at trial show that the interests of the Debtor and the Club are remarkably aligned and that the actions taken by the Club with respect to the Rink's operations have in fact benefitted both the Club and the Debtor.
For example, Mr. Grewal testified that the Club has financially supported the Rink since its inception. This support is evidenced by: (1) the Club financed the purchase of a Zamboni machine for the Debtor; (2) it made a $10,000 contribution to the Debtor's figure-skating program; (3) it purchased a copy machine for the Rink; and (4) most significantly, it executed a guaranty of the Debtor's bond debt.
Wells Fargo did not dispute these facts at trial, but it argues that the Club's guaranty of the Debtor's Bonds is meaningless because the Club does not have the funds necessary to honor the guaranty in full. It does not follow, however, that the Club's guaranty is meaningless. If anything, the Club's lack of adequate funds to honor the guaranty in full only proves that the Club's very survival depends upon the Debtor's ability to pay the debt. The Club's guaranty ensures that the Club and the Debtor shall sink or swim together.
Wells Fargo argues that when the Club removed Mr. LaPato and Mr. Willet, the only two members of the board of managers who were not Club members, the Club cemented total control over the Debtor, and this control creates a conflict of interest. The evidenced adduced at trial demonstrated that the Club controls the Debtor. However, this control does not itself create a conflict of interest.
In addition, the undisputed evidence shows that replacement of these two former board members cured actual conflicts of interest that had been exploited by Messrs. Willett and LaPato to the detriment of the Debtor. For example, in addition to being a member of the previous board, Mr. Willet was the treasurer of Crystal Lake South High School. He used his position as board member to benefit Crystal Lake South High School to the Debtor's detriment by negotiating for his high school the cheapest ice rental rates of any customer, whereas the Club has always paid the highest rates of any licensee.
The removal of Mr. LaPato from the board of managers cured multiple conflicts of interest. The evidence was undisputed that Mr. LaPato employed various family members at the Rink and some of these employees were paid by the Debtor for work done at other rinks. The undisputed testimony of Michael D. Pakter, the Debtor's expert witness, was that many of the previous management's expenses, including
The Club's control of the Debtor by itself does not create a conflict of interest because it is in the best interests of both the Debtor and the Club to take all steps necessary to ensure the financial health of the Debtor. Moreover, the Debtor is a closely-held entity whose reputation and goodwill are closely identified with its owners because the success of the Club is inextricably tied to the success of the Debtor: "The preference for retention of current management is stronger where the Debtor is a closely-held entity whose reputation and good will is closely identified with its owners and/or management team." 4 C Solutions, 289 B.R. at 370. For this reason, the Court finds a strong preference to retain current management over the appointment of a trustee, and the Court finds that Wells Fargo has not introduced enough evidence to overcome that preference.
Wells Fargo next alleges that the Club pays a below-market rate for ice time at the Rink and this fact demonstrates that the Club has acted upon a conflict of interest to the detriment of the Debtor. The problem with this argument is that neither party introduced evidence which would show the relevant market price for ice time for long-term customers. Instead, Mr. Grewal testified without contradiction that the Club's current payment of $325 per hour is the highest rate paid by any of the Debtor's licensees. His unrebutted testimony removes the factual basis for Wells Fargo's claim of self-dealing.
Wells Fargo also argues that the Club has acted against the Debtor's interests by attempting to negotiate preferential ice times and a lower effective rate.
Wells Fargo alleges that self-dealing is demonstrated by the lack of a formal, written ice rental agreement between the Debtor and the Club, and by the Debtor's agreement to allow the Club to stretch out its ice time for equal monthly payments without regard to actual ice time used in any particular month. It is undisputed that the Club has never had a written, executed agreement with the Rink under either the prior or current management. (Ex. No. 5.) But this fact does not establish self-dealing because Mr. Grewal testified without contradiction that the Club has paid its bills every month since the inception
Nor is there merit to Wells Fargo's claim that the Club's scheduled payments were stretched out without consideration. Mr. Grewal testified that the Club had previously paid the Debtor on a monthly basis based on actual ice time used during that month. The Debtor asked the Club to spread out its payments evenly over the course of the year in order to mitigate the natural annual drop-off in revenue in the summer months and thereby create a more predictable cash flow for the Debtor. The Court finds that this benefit to the Debtor provided adequate consideration for the agreed-upon alteration to the Club's payment schedule.
It is undisputed that in current negotiations between the Debtor and Team Illinois for ice rates and times, the Debtor's general manager, Paul O'Dacre, received input from Danielle Gulli, a Club executive and the former president of the Club.
The Court finds that there was no evidence that Ms. Gulli's access to information during the negotiations for ice time between the Debtor and Team Illinois adversely impacted those negotiations. Moreover, because of the Club's guaranty of the Debtor's indebtedness to Wells Fargo, it is in the Club's self-interest to ensure the Debtor's success. No evidence was introduced to suggest that the Club took any actions inconsistent with the Debtor's interests in reaching fair agreements with all of the Debtor's licensees.
For all of these reasons, the Court finds that Wells Fargo failed to demonstrate by clear and convincing evidence that the Debtor acted in a fashion detrimental to the Debtor's interest.
Wells Fargo argues that certain actions taken by the Debtor amounted to fraud or gross mismanagement, necessitating the appointment of a trustee under § 1104(a)(1). In support of this assertion, Wells Fargo argues that: (1) the Debtor lacks adequate internal controls; (2) the Debtor failed to maintain adequate books and records; (3) the Debtor violated Cash Collateral Orders; (4) the Debtor lacked adequate process for selecting new management; (5) the Debtor lacks a strategic plan to pay back its bond debt; (6) the Debtor made unnecessary pre-petition expenditures; (7) the payment to certain vendors without proper invoices is an indicia of fraud; and (8) the Debtor made prepetition
The Debtor's internal control procedures require that all checks of the Debtor are to be signed by two people. (Ex. Nos. 3 & 17.) Wells Fargo introduced evidence that the Debtor did not comply with its internal controls when it allowed Mr. Grewal to be the sole signatory on numerous checks that were written just before the Petition Date. Those checks include the following:
The Court agrees with Wells Fargo that the Debtor violated its internal control policies when only one person signed these checks. However, this violation of the internal controls alone is not sufficient to establish that the Debtor's failure amounted to gross mismanagement or fraud. For the reasons stated above, departure from its internal control policy was justified because these expenses were necessary for the proper operation of the Rink.
The Debtor's internal control policy states, "[i]t is the policy to only pay from original invoices in hand, no statements or order acknowledgements will be allowed." (Ex. No. 17, p. 3.) Wells Fargo points to several instances when the Debtor violated this policy by paying several vendors without official invoices:
The Court agrees with Wells Fargo that the Debtor violated its internal control policies when it made payments to vendors from documents other than original invoices in hand. However, this violation of the internal controls by itself is not sufficient
Mr. Cordes testified that the Debtor does not have in place either effective internal controls or a method for ensuring that management adheres to any such controls. In response, Mr. Pakter and Mr. Grewal both testified that the Debtor had been forced to recreate its books and records because the prior management company refused to turn over the Debtor's books and records when their services were terminated. Mr. Pakter testified that he has worked with the Debtor to improve and maintain proper internal controls and the Debtor has made and implemented improvements to its internal control structure. Thus, far from establishing gross mismanagement, the evidence showed that the Debtor has acted diligently to recreate and employ proper accounting and recording methods, despite the handicap imposed upon it by its prior management company.
Similarly, Wells Fargo argues that the Debtor failed to maintain accurate and complete financial records. Specifically, Wells Fargo argues that for the financial periods of March 1-9, March 10-16, March 17-23, March 24-31, April 1-7, April 8-14 and April 15-21 of 2013 the Debtor failed to: (1) reconcile its general ledger and bank accounts to reflect all activity that has occurred; (2) reconcile its pre-petition unsecured claims in its accounting system with those listed on its schedules; and (3) record ATM activity. (See Exhibit Nos. 29-32, 36 & 38.)
The Debtor's response to this argument is the same as its response to Wells Fargo's arguments regarding lack of internal controls: The Debtor was required to recreate its books and records when former management failed to turn over the Debtor's books and records to new management. Mr. Pakter testified that these financial issues have now been resolved, and the Debtor now has procedures in place that allow it to maintain proper financial records. Mr. Pakter testified that the Debtor's financial records are up to date through April 2013 and that the general ledger is currently balanced with the Debtor's bank statements. Mr. Pakter stated because those records are now balanced, all previous months are necessarily balanced as well. He concluded that it was his opinion that the Debtor now has control over its financial reporting system.
Mr. Cordes and Mr. Pakter next sparred over the following alleged accounting failures by the Debtor:
Wells Fargo also argues that there were discrepancies between the Debtor's accounting records and the documents it filed in connection with the bankruptcy case. The Court finds that these discrepancies were a direct result of the initial incompleteness of the Debtor's financial records caused by prior management's refusal to turn over the Debtor's books and records. They are not evidence of gross mismanagement on the part of the Debtor.
Wells Fargo argues that the Debtor has not timely met its financial reporting requirements. The Debtor does not dispute that its audited financial statements for June 30, 2011 were not issued until April 29, 2012. Further, the Debtor admits that it has failed to produce audited financial statements for the fiscal year ending June 30, 2012, which were due December 31, 2012. However, as previously stated, these failures are attributable to the refusal of the Debtor's prior board of managers to turn over the Debtor's books and records.
Thus, while the Court agrees with Wells Fargo that the Debtor has not timely met its financial reporting requirements, this violation, under the circumstances, does not establish by clear and convincing evidence
Wells Fargo argues that the Debtor violated the terms of the Cash Collateral Orders and that these violations, in and of themselves, are evidence of gross mismanagement amounting to cause to appoint a trustee. Specifically, Wells Fargo complains that the Debtor paid expenses
The Cash Collateral Orders state: "the Debtor may use Cash Collateral in excess of the amount designated for a particular line-item so long as the percentage of deviation for each line-item during any monthly period does not exceed ten percent (10%) per line-item and, in addition, does not exceed ten percent (10%) in aggregate...." (Ex. Nos. 34 & 35) (emphasis added).
Wells Fargo interprets this language in the disjunctive: That is, under Wells Fargo's interpretation, if the Debtor is either 10% over on a single line item or 10% over the aggregate budget, then the Debtor will have violated the Cash Collateral Orders. Wells Fargo argues that the Debtor's expenses for certain line items exceeded 10% of the budgeted amount for those particular items, even though the Debtor's overall expenses did not exceed 10% of the total expenses allowed under the cash collateral budget. Under Wells Fargo's interpretation of the Cash Collateral Orders, this violated those Orders.
The Debtor counters that Wells Fargo's argument fails because it is based upon a fundamental misinterpretation of the Cash Collateral Orders. Under the Debtor's analysis, the expense-variation language in the Orders must be read in the conjunctive, rather than the disjunctive: That is, under the Debtor's interpretation, it only violated those Orders if it incurred expenses of more than 10% over any single line item and also incurred total expenses which were 10% over the aggregate budget.
Mr. Grewal thus testified that he interpreted the Cash Collateral Orders to mean that the Debtor would be in violation of them only if its spending was 10% more than the budget for each line-item and also 10% above the budget for all line-items in the aggregate.
The Court finds Mr. Grewal's trial testimony with respect to his understanding of the Cash Collateral Orders credible. The Court also finds that both the Debtor's and Wells Fargo's interpretations of the Cash Collateral Orders are plausible. The ambiguity surrounding the interpretation of the Orders demonstrates that Wells Fargo has not established by clear and convincing evidence that the Debtor violated the Cash Collateral Orders.
In sum, the Court finds that the Cash Collateral Orders are properly interpreted in the conjunctive, and that under this interpretation the Debtor did not violate them. Wells Fargo has therefore not established that the Debtor is guilty of gross mismanagement. Consequently, the Court finds that there is no "cause" warranting the appointment of a trustee.
Wells Fargo alleges that the Debtor failed to create necessary and ordinary processes for the selection of management and therefore has grossly mismanaged its affairs. According to Mr. Cordes, the Debtor: (1) had a flawed process with respect to hiring its new manager; (2) did not confer with Wells Fargo; and (3) did not allow for an adequate transition period between the management companies. The Court finds that the transition period was sufficient to replace new management, particularly given the drastic steps that were quickly required to remedy the poor physical and financial condition at the Rink in December of 2012: (1) there was a $1,000,000 default to the bondholders; (2) the real estate taxes on the Rink, years in arrears, had been sold, and then had to be redeemed; (3) the Board was unable to get CSCG to cooperate with respect to questions about payroll; (4) CSCG did not appear to be accurately reporting revenues for ATM, vending and concessions transactions; (5) the concessions area was being improperly sublet by CSCG; and (6) the Debtor's training facility (known as the "Pinnacle") was improperly staffed, stocked with unnecessary equipment and offered ineffective programs; these problems caused the Club and Team Illinois to quit using the Pinnacle, and that in turn led to reduced revenue.
Moreover, the evidence demonstrates that the Debtor went through a careful selection process when it selected and hired new management. Mr. Grewal testified that the Debtor solicited proposals from three different management companies. It received two proposals, reviewed them, and interviewed the two companies' personnel. Ultimately, it selected and contracted with Fairview. (Ex. No. 16.). Mr. Grewal testified that the Debtor's board only replaced CSCG after it had completed this interview process.
Wells Fargo further argues that the Debtor also grossly mismanaged the management transition when it included an incentive compensation program in the
Wells Fargo argues that the Debtor lacks a strategic plan to deal with its default on the bond debt. But one of the Debtor's purposes in filing this case was to give it breathing room to create a strategic plan to pay all of its debts, including debts owed to Wells Fargo. Wells Fargo's concern with the lack of a plan at the inception of the proceedings is thus premature. Furthermore, the Debtor provided evidence that it is capable of making progress towards paying back the Bonds because revenues have increased since the Petition Date.
Finally, Wells Fargo argues that the Debtor has not been transparent in its dealings with Wells Fargo. No evidence was introduced that the Debtor was required to consult with Wells Fargo with respect to the Debtor's management of the Rink. Nonetheless, the Debtor's cooperation with Cordes & Company and the weekly reports generated by Cordes & Company provided Wells Fargo with far more transparency than it enjoyed from prior management.
Mr. Cordes testified that it was not prudent for the Debtor to have made significant pre-petition capital improvements when it lacked the funds to do so and that, in any event, the Club rather than the Debtor should have absorbed those costs. However, there was no evidence to support the claim that the Debtor requires any of its licensees to finance capital improvements made to the Rink for the benefit of customers. The only documentary evidence bearing on this issue at all is the Debtor's written contract with Team Illinois. Tellingly, that contract does not require the licensee to absorb the
Mr. Grewal also testified, without rebuttal from Mr. Cordes or any other witness, that in his best business judgment each of these expenditures was necessary in order to have a safe and properly operating business.
In conclusion, the Court finds that these capital expenditures were essential in order for the Rink to operate as a safe, efficient and successful business. The Court also finds no reason for the Debtor to have required the Club alone to absorb those costs. As a result, the Court finds that these expenditures do not amount to gross mismanagement.
Finally, Wells Fargo argues that the manner in which the Debtor paid certain pre-petition expenditures constitutes fraud.
Section 1104(a) does not define fraud: "The cases in which fraud on the part of the debtor in possession justified the appointment of a trustee are not numerous and rest on clear and convincing facts." In re F.A. Potts & Co., 20 B.R. 3, 5 (Bankr.E.D.Pa.1981). Cases defining § 1104(a)(1) fraud do so by reference to state common law fraud elements. See id. Under Illinois law, the elements of fraud include: (1) a false statement of material fact; (2) the defendant's knowledge or belief that the statement was false; (3) intent to induce the other party to act; (4) the other party's justifiable reliance upon the statement; and (5) damage resulting from such reliance. Brown v. Real Estate Res. Mgmt., LLC (In re Polo Builders, Inc.),
Wells Fargo's main charge of fraud centers on the Debtor's actions with respect to Thom Infotech. Wells Fargo's primary evidence for this alleged fraud is an email exchange between Michele Kackert, the Debtor's accountant, and Thom Infotech in which Ms. Kackert allegedly asked the vendor to backdate an invoice. (Ex. No. 24.) No testimony or evidence was offered by either party that would shed light on the actual intentions of the two parties to the email exchange. However, a reasonable interpretation of Ms. Kackert's email is that she wanted Thom Infotech's invoice to accurately reflect the date of purchase rather than the date of delivery. In addition, the invoice itself appears to be internally inconsistent because it contains dates that cannot be reconciled.
Wells Fargo also argues that an invoice from Innovative Concepts in Entertainment Inc. demonstrated that the Debtor committed fraud by allegedly demanding an altered invoice from the company. (Ex. No. 113.) Specifically, Wells Fargo argues that the pro forma invoice and the altered "paid by" date of the other invoice are sufficient to prove that the Debtor committed fraud. Because there was no evidence produced at trial that the dates of either invoice were altered at the request of the Debtor, the Court finds that Wells Fargo failed to prove by clear and convincing evidence that either invoice proves that the Debtor committed fraud.
Wells Fargo next alleges that Mr. Grewal backdated the check to Innovative Concepts, and that such conduct amounts to fraud. (Ex. No. 106.) There was insufficient evidence adduced at trial that would allow this Court to conclude that Mr. Grewal in fact backdated that check and thus committed fraud. Wells Fargo argues that the inconsistencies between the invoice and the pro forma invoice, coupled with the check that was dated February 21, 2013 is enough to prove fraud. However, no testimony was offered that allows this Court to conclude anything other than the Debtor requested invoices that accurately depicted the timeline for this purchase.
Next, Wells Fargo argues that certain emails between Mr. O'Dacre and MSI, Inc. sent on February 22, 2013, the Friday before the Petition Date, demonstrate that the Debtor was fraudulently attempting to create a false paper trail. In his email, Mr. O'Dacre stated to a representative of MSI, that "I need to get you paid today so if you have to inflate it to make sure everything is covered we can adjust moving forward. Get that to me asap." (Ex. No. 23.) Wells Fargo alleges that the term "inflate" used by Mr. O'Dacre shows that the Debtor was trying to falsify financial records.
Wells Fargo further alleges that the Debtor committed fraud when it prepaid Metrolift, Inc. for a scissor lift that had not yet been delivered. Wells Fargo's evidence for this argument is: (1) the Debtor's check to Metrolift dated February 21, 2013 (Ex. No. 22); (2) Metrolift's quote dated February 25, 2013 (Ex. No. 20); and (3) Mr. O'Dacre's email to Metrolift stating, "I know you said there would be some wiggle room so see if you can let us have the unit we used for the last couple of weeks as the wiggle room and you keep the enclosed check. I think that would be fair and you have another new customer." (Ex. No. 21.)
Mr. O'Dacre testified that the purpose of his email was to ask Metrolift to waive the rental fee and accept the payment without such fee as a full payment for the scissor lift. The Court finds Mr. O'Dacre's explanation plausible and further finds that Wells Fargo did not prove by clear and convincing evidence that his conduct amounted to fraud.
Wells Fargo also argues that the Debtor also committed fraud through an email written by Mr. O'Dacre to a representative of Rink-Tec in which Mr. O'Dacre stated, "[w]e added a $1000 onto the one in case they filed 11 can you just use that as a credit going forward?" (Ex. No. 27.) Mr. O'Dacre testified that in his business judgment, a small advance to Rink-Tec, a new vendor, would help ensure that Rink-Tec would continue to work with the Debtor moving forward. The Court finds Mr. O'Dacre's explanation plausible and finds that his actions do not rise to the level of fraud.
Wells Fargo next argues that the Debtor's purchase of office furniture from Business Office Systems amounted to fraud. On February 22, 2013. Mr. O'Dacre sent the vendor an email stating, "[c]an you send over an invoice for the [Rink] furniture so we can [get] you paid. Keep it under $5000 and if you have [to] adjust later not a problem we want to cut the check today." (Ex. No. 28.) Mr. Grewal testified that the Debtor purchased office furniture in order to convert a single-desk room at the Rink into a three-desk office. Mr. O'Dacre testified that the Debtor used this vendor in the past and his email was intended to obtain the best deal he could on the purchase of the furniture. The evidence adduced at trial demonstrates that the Debtor paid for the office furniture on February 22, 2013. (Id.) The delivery date was not until mid-March of 2013, and the check was not cashed until that time. The Court concludes that those facts are insufficient to demonstrate that the Debtor committed fraud. (See Ex. Nos. 28 & 111.)
In addition, Wells Fargo maintains that the Debtor improperly paid over $32,000 in pre-petition claims post-petition without Court approval, and those payments amount to gross mismanagement. (Ex. Nos. 29 & 30.) Of these payments, only two categories were significant in amount:
In sum, the Court finds that all of these payments were either de minimus in amount or vital to the proper operation of the Rink. None of them were evidence of gross mismanagement.
Wells Fargo argues that the Court must look at the totality of the circumstances when determining if a debtor either grossly mismanaged its affairs or committed
In determining the alleged malfeasance which should be viewed as a whole, the Court will exclude those allegations that Wells Fargo failed to establish as a factual matter that the Debtor: (1) lacked adequate process when it replaced management; (2) had a conflict of interest with the Club; (3) engaged in any self-dealing; or (4) violated the Cash Collateral Orders. Because Wells Fargo failed to establish any of these allegations, the Court will not consider them as part of the totality of the circumstances.
When the remaining allegations of malfeasance are examined as a whole, they do not amount to proof of gross mismanagement or fraud. For example, the capital improvements made on the eve of bankruptcy were necessary for the safe and efficient operation of the Rink, thereby demonstrating good management rather than bad. Similarly, the Debtor's pre-petition payments of post-petition debts were either justified by business necessity or were de minimus. While these actions could be construed as mismanagement, they do not constitute gross mismanagement. Because "one would expect to find some degree of incompetence or mismanagement in most businesses which have been forced to seek the protections of chapter 11, the Court must find something more aggravated that simple mismanagement" in order to appoint a trustee. Midlantic Nat'l Bank v. Anchorage Boat Sales, Inc. (In re Ancorage Boat Sales, Inc.), 4 B.R. 635, 645 (Bankr.E.D.N.Y. 1980). In short, even when looked at as a whole, Wells Fargo's allegations of malfeasance are insufficient to establish that the Debtor either grossly mismanaged its affairs or was guilty of fraud.
Next, the Court will address whether the appointment of a trustee is warranted under § 1104(a)(2) because such an appointment "is in the interests of creditors, any equity security holders, and other interests of the estate...." 11 U.S.C. § 1104(a)(2). When discussing this section of the Code, Collier on Bankruptcy states:
A. Resnick and H. Sommer, 7 Collier on Bankruptcy, § 1104.02[3][d][i], at 1104-15 (16th ed. 2013). The Court finds that § 1104(a)(2) must be read in the conjunctive, and that the appointment of a trustee
The Court finds that Wells Fargo has not shown by clear and convincing evidence that the appointment of a trustee is necessary under § 1104(a)(2). The evidence offered at trial did not establish that a trustee would be in the interests of any other creditors or equity security holders.
In support of its request for the appointment of a trustee, Wells Fargo offered the testimony of Ms. Housum, a vice president in the corporate trust department at Wells Fargo. She testified that the Debtor replaced its prior management without consulting Wells Fargo and the other bondholders. She further testified that under the Debtor's old management, there were monthly conference calls between the Debtor and the bondholders, and there was "transparency" with the old board. She stated that since the new management was put in place, those calls have not taken place and the transparency has disappeared. Ms. Housum also testified that Wells Fargo has no confidence in the Debtor's ability to manage the Rink because of a perceived conflict of interest between the Debtor and the Club. In fact, she called the relationship "incestuous." She further stated that there is now no working relationship between the Debtor and Wells Fargo. She also testified that the Debtor did not seek the approval of the bondholders before making all of the capital improvements at the Rink.
As previously stated, the Court rejects the argument that there is a conflict of interest between the Debtor and the Club or that the Club under its new management company acted to the Debtor's detriment. The Court finds Ms. Housum's testimony that the Debtor is not committed to paying back its bond debt speculative and unconvincing. The Debtor is not required to have a strategic plan in place to pay back the debt immediately upon filing its bankruptcy petition. As noted previously, one of the purposes of filing this case was to give the Debtor breathing room to create a strategic plan to pay back its debts. Further, the Debtor's default on its bond payments occurred under prior management, which has now been replaced, and the new management appears to be working diligently to address the multitude of problems faced by the Debtor.
Ms. Housum further stated that Wells Fargo is not receiving sufficient financial information from the Debtor. But this argument fails to take into account the critical role being played by Wells Fargo's expert witness, Mr. Cordes, and his company, Cordes & Company. Mr. Cordes has virtually unlimited access to the Debtor's books and records, and his company prepares detailed weekly reports for the benefit of Wells Fargo. In terms of the actual information received, it appears to the Court that Wells Fargo is receiving far more information from the new management of the Debtor than it received from the old, even though Ms. Housum clearly preferred the old management's way of conveying its information. Thus, the Court finds that Wells Fargo receives the information necessary to assess the Debtor's ability to manage the Rink.
Next, Ms. Housum testified that the Debtor does not have adequate cash controls in place. The Court agrees with Wells Fargo that under previous management insufficient internal controls were implemented to properly control the Debtor's cash. However, under new management, the Debtor has made a good faith effort to remedy this situation and has, with the help of Mr. Pakter, instituted new internal controls. The evidence demonstrated that since the Petition Date the Debtor increased its revenues and reduced
This Court finds that the actions taken by the Debtor were necessary to address problems created by prior management. There was no evidence adduced at trial, other than Ms. Housum's unqualified opinion as to legal matters, that would allow this Court to find that an irreconcilable conflict of interest exists between the Club and the Debtor.
Relying on the case In re Marvel Entm't Grp., Inc., 140 F.3d 463 (3d Cir. 1998), Wells Fargo argues that its lack of trust in the Debtor mandates appointment of a trustee. However, in Marvel the court stated, "[w]e expressly hold that there is no per se rule by which mere conflicts or acrimony between debtor and creditor mandate the appointment of a trustee." Id. at 473. This Court finds that the mere acrimony between Wells Fargo and the Debtor is insufficient to warrant the appointment of a trustee. The "intense and high-stakes bickering" present in that case is not present here. See id. at 474. The level of animosity between this Debtor and Wells Fargo does not reach the level of animosity that was present in the Marvel case.
Thus, the apparent break-down in communication between the Debtor's new board and Wells Fargo does not by itself constitute grounds necessary to appoint a trustee. Ms. Housum's testimony that she has lost confidence in the Debtor's ability to manage the Rink and is "skeptical" of any possibility to work with the Debtor is insufficient to demonstrate that appointment of a trustee is in the interests of all creditors, equity security holders, and other interests of the estate. To the contrary, Ms. Housum admitted that she was unaware of the state of disrepair at the Rink under the old management even though she was at the facility in September 2012 and took a tour of the building.
Wells Fargo failed to produce sufficient evidence to demonstrate that its lack of confidence in the Debtor is so justified that it would be in the best interests of creditors, equity security holders, and other interests of the estate to appoint a trustee. In fact, most of the evidence adduced at trial should, if anything, help to restore Wells Fargo's confidence in the Debtor. Under new management the Debtor has: (1) repaired the abysmal conditions of the Rink; (2) reduced utility costs; (3) reduced the Rink's potential liabilities; (4) reconciled the Rink's financial records; (5) developed new internal controls; (6) increased revenues; and (7) begun the process of renegotiating contracts more favorable to the Debtor.
In conclusion, the Court, under the discretion afforded it by § 1104(a)(2), declines to appoint a trustee. The Court finds that Wells Fargo failed to show by clear and convincing evidence that it is in the interests of creditors, any equity security holders, and other interests of the estate to appoint a trustee.
For the foregoing reasons, the Court finds, based on the totality of the evidence, that Wells Fargo has not demonstrated by clear and convincing evidence that a Chapter 11 trustee should be appointed under § 1104(a)(1) or (a)(2). Wells Fargo has not demonstrated evidence of "cause" including fraud, gross mismanagement, or dishonesty on the part of the Debtor, or that it would be in the interests of creditors, equity security holders, and other interests of the estate to appoint a trustee.
