TIMOTHY A. BARNES, Judge
The matter before the court arises out of the Motion To Dismiss Case [Dkt. No. 11] (the "Motion"), filed by BCL-Bridge Funding LLC ("BCL"), seeking dismissal for cause under section 1112(b) of the Bankruptcy Code (as defined below) of the chapter 11 case of Lake Michigan Beach Pottawattamie Resort LLC (the "Debtor"). BCL alleges that because the Debtor filed its bankruptcy petition on the eve of foreclosure and without BCL's approval as a member of the Debtor, the case was filed in bad faith and must be dismissed.
The matter was argued before the court on January 27, 2016 (the "Hearing") and the court delivered its ruling orally on March 2, 2016. For the reasons set forth herein, the court holds that BCL failed to show that the Debtor filed this case in bad faith. Further, the Debtor was not prohibited from filing the case under its existing corporate control documents.
The federal district courts have "original and exclusive jurisdiction" of all cases under title 11 of the United States Code (the "Bankruptcy Code"). 28 U.S.C. § 1334(a). The federal district courts also have "original but not exclusive jurisdiction" of all civil proceedings arising under title 11 of the United States Code, or arising in or related to cases under title 11. 28 U.S.C. § 1334(b). District courts may, however, refer these cases to the bankruptcy judges for their districts. 28 U.S.C. § 157(a). In accordance with section 157(a), the District Court for the Northern District of Illinois has referred all of its bankruptcy cases to the Bankruptcy Court for the Northern District of Illinois. N.D. Ill. Internal Operating Procedure 15(a).
A bankruptcy judge to whom a case has been referred may enter final judgment on any proceeding arising under the Bankruptcy Code or arising in a case under title 11. 28 U.S.C. § 157(b)(1). A proceeding for dismissal of a bankruptcy
Accordingly, final judgment is within the scope of the court's authority.
In considering the relief sought by BCL, the court has considered the evidence and argument presented by the parties at the Hearing, has reviewed the Motion, the attached exhibits submitted in conjunction therewith, and has reviewed and found each of the following of particular relevance:
Though the foregoing items do not constitute an exhaustive list of the filings in the case, the court has taken judicial notice of the contents of the docket in this matter. See Levine v. Egidi, No. 93C188, 1993 WL 69146, at *2 (N.D.Ill. Mar. 8, 1993) (authorizing a bankruptcy court to take judicial notice of its own docket); In re Brent, 458 B.R. 444, 455 n. 5 (Bankr. N.D.Ill.1989) (Goldgar, J.) (recognizing same).
This case is essentially a fight over the main asset of the Debtor, a vacation resort in Coloma, Michigan that hosts multiple condominium units and a cabin that are seasonally rented, and undeveloped land, all on 15.5 acres (the "Property"). With respect to the Property, the Debtor granted a mortgage and assignment of rents to BCL on December 18, 2014 to secure a $1,336,000.00 loan and $500,000.00 line of credit given by BCL to the Debtor.
The Debtor defaulted on its monetary obligations to BCL in July 2015. In exchange for a promise from BCL that it would forbear from pursuing remedies for the default until October 21, 2015, the Debtor signed an agreement (the "Forbearance Agreement") on August 21, 2015 wherein the Debtor stipulated to a monetary default in the amount of $2,641,147.89 and promised to pay that amount in full by October 21, 2015. The Debtor also made further promises to BCL, one of which was to execute a third amendment to its operating agreement (the "Third Amendment")
Id. at Article 12.2(vi), p.2 (emphasis added). BCL, in its capacity as the Special Member of the Debtor, has no interest in the profits or losses of the Debtor, no right to distributions or tax consequences and is not required to make capital contributions to the Debtor—essentially, BCL was kept separate and apart from the Debtor in all ways but for its authority to block the Debtor from petitioning for bankruptcy relief. Id. at Article 12.4(iii), p. 2. Further, when exercising its rights under the Third Amendment, BCL is not obligated to consider any interests or desires other than its own and has "no duty or obligation to give any consideration to any interest of or factors affecting the Company or the Members." Id. at Article 12.4(iv), pp. 2-3.
Shortly following the execution of the Third Amendment, the Debtor once again failed to fulfill its monetary obligations to BCL, by failing to meet the October 21, 2015 deadline under the Forbearance Agreement to pay BCL in full. Following this default, BCL filed a foreclosure complaint against the Third Party Property on November 2, 2015 and against the Property on November 3, 2015. With respect to the latter, BCL published notice of a December 17, 2015 non-judicial foreclosure sale for three weeks in the Berrien County Record, the local newspaper for where the Property is located.
On December 16, 2015 (the "Petition Date"), the Debtor petitioned for relief under chapter 11 of the Bankruptcy Code. As a result, the foreclosure sale was not held as scheduled. Attached to the Debtor's petition is a consent to file bankruptcy signed by four members of the Debtor. A signature on behalf of BCL, as the Special Member, was not included. The Debtor agrees that BCL has not consented to the Debtor's bankruptcy petition and that this case was filed on the eve of the foreclosure sale.
The Debtor has provided broker price opinions for each of the rental units and the undeveloped acreage that support a valuation of the Property, as of the Petition Date, exceeding the $6,000,000.00 value scheduled by the Debtor. BCL has not filed a claim, but given the amount set forth in the Forbearance Agreement less
BCL argues that the Debtor's bankruptcy petition is a bad faith litigation tactic to stall the foreclosure process and, accordingly, grounds for dismissal exist. Such grounds are asserted on motions to dismiss on a regular basis in this court. Had that been the extent of BCL's argument, this matter could have been handled summarily, as will be seen below. The argument with respect to the validity of the Debtor's bankruptcy petition, however, requires more. The court will address all arguments in turn.
A court may dismiss a chapter 11 case if cause is established and such cause merits dismissal rather than conversion. 11 U.S.C. § 1112(b). The party seeking dismissal bears the burden of proof by a preponderance of the evidence. In re Woodbrook Assocs., 19 F.3d 312, 317 (7th Cir.1994). Cause, however, is not definitely established by the statute. Section 1112(b)(4) provides courts with a nonexclusive list of factors that may constitute cause for dismissal, 11 U.S.C. § 1112(b)(4), which list does not include bad faith.
A chapter 11 case is infirm if not filed in good faith and, therefore, courts in this Circuit have found that the lack of good faith can constitute "cause" for dismissal of a case under section 1112(b). In re Madison Hotel Associates, 749 F.2d 410, 426 (7th Cir.1984); In re Tekena USA, LLC, 419 B.R. 341, 346 (Bankr. N.D.Ill.2009) (Cox, J.). As with intent, courts look at each bankruptcy filing on a case-by-case basis to determine whether factors indicative of a debtor's good or bad faith are present. See Tekena USA, LLC, 419 B.R. at 346; In re S. Beach Sec., Inc., 341 B.R. 853, 857 (N.D.Ill.2006) (citing In re Integrated Telecom Express, Inc., 384 F.3d 108, 118 (3d Cir.2004)) ("Each bankruptcy petition, however, arises under different circumstances and raises particular concerns, requiring a court to examine the debtor's unique situation to determine where `a petition falls along the spectrum ranging from the clearly acceptable to the patently abusive.'").
Tekena and the factors enumerated therein have been cited by many creditors seeking dismissal, including BCL, as the checklist that a court should use to examine whether a debtor acted in good or bad faith in filing its bankruptcy petition. 419 B.R. 341. The so-called "Tekena factors"
Tekena, 419 B.R. at 346. The factors BCL relies on in making its bad faith argument in the Motion are factors 1, 2, 6, 7, 8, 9 and 12, though at the Hearing, counsel for BCC summarily argued that all Tekena factors were met and no clearer case for dismissal than this case could exist. The arguments made in the Motion are the grounds upon which BCL primarily relies and are, coincidentally, the only ones bearing any relation to this case. The court will, therefore, address only the factors enumerated in the Motion without considering the remaining Tekena factors.
BCL argues that the first Tekena factor is satisfied because it is the only "real" secured creditor of the Debtor. BCL puts so much stock in this assertion that it italicizes the term "real" when using it in the Motion.
This assertion is, however, flawed. There is no test as to whether a creditor is "real" or not in the relevant statutory or case law. Further, concentrating on only secured creditors can lead to mistaken results.
BCL has not filed a claim in this case. Instead, other than the exhibits attached to the Motion, BCL relies on the Debtor's schedules, listing BCL as a secured creditor, to establish its status. The exhibits, of course, are not evidence, while the Debtor's schedules, signed under penalty of perjury, may be. Thus, the only evidence the court has is the Debtor's schedules.
Concentrating on the schedules, however, leads to the unavoidable conclusion that BCL is not the only creditor. The Debtor also scheduled Pottawattamie Resort Condominium Association as having a secured claim and Erica Friedman as holding an unliquidated, unsecured claim, based on pending litigation. No objections to the scheduling of these claims has been raised, and in a chapter 11 case, scheduled claims are presumptively valid until adjudicated otherwise. 11 U.S.C. § 1111(a). The Debtor, therefore, has at least three creditors.
BCL's argument that it is the only "real" creditor in this case, therefore, fails under the Bankruptcy Code and under its own analysis. The first Tekena factor is not satisfied.
BCL's argument regarding the second Tekena factor—whether there was a previous bankruptcy petition by the Debtor or a related entity—strains its credibility. BCL argues that the Debtor's default somehow equates to a prior bankruptcy. That the Debtor was in default to BCL is not indicative of bad faith.
BCL repeatedly argues in the Motion and argued at the Hearing that the most compelling indication of bad faith is the timing of the Debtor's bankruptcy petition—on the eve of foreclosure. The Debtor does not dispute the timing but argues that the foreclosure would have resulted in a large windfall to BCL and that the petition for bankruptcy relief was filed to preserve equity in the Property.
This is, in the court's view, the most abused of the Tekena factors. Parties presume that if this factor is satisfied, bad faith must exist. This is simply not correct. "It is well settled, of course, that the filing of a bankruptcy petition on the eve of a foreclosure or eviction does not, by itself, establish a bad faith filing." In re Eclair Bakery Ltd., 255 B.R. 121, 137 (Bankr.S.D.N.Y.2000). Again, bad faith requires this court to review the totality of the circumstances regarding a petition for bankruptcy relied, not just an isolated factor. While BCL is correct that the sixth factor is satisfied, taken alone, this factor is unpersuasive.
BCL also is correct that the seventh factor is satisfied—the Property is the major asset of the Debtor. Again, this factor is not outcome determinative. Even assuming that this were the only asset of the Debtor, this alone would not suffice.
In re 203 N. LaSalle St. Ltd. P'ship, 190 B.R. 567, 590 (Bankr.N.D.Ill.1995) (Wedoff, J.), aff'd Bank of Am., Illinois v. 203 N. LaSalle St. P'ship, 195 B.R. 692 (N.D.Ill.1996), aff'd In re 203 N. LaSalle St. P'ship, 126 F.3d 955 (7th Cir.1997), rev'd on other grounds, Bank of Am. Nat. Trust & Sav. Ass'n v. 203 N. LaSalle St. P'ship, 526 U.S. 434, 119 S.Ct. 1411, 143
The Debtor is not currently operating. Chapter 11 relief, however, is not reserved for only operating businesses. Debtors in chapter 11 cases may refinance debts or sell all or part of their assets in order to maximize value in an operational or nonoperational setting. In re Chicago Const. Specialties, Inc., 510 B.R. 205, 215 (Bankr.N.D.Ill.2014) (Barnes, J.) ("Despite being entitled `Reorganization,' chapter 11 expressly contemplates liquidating plans of reorganization."); see also, e.g., 11 U.S.C. § 1123 (A plan may "provide for the sale of all or substantially all of the property of the estate, and the distribution of the proceeds of such sale among holders of claims or interests.").
BCL does not dispute that there is equity in the Property. That equity may be used to reorganize the Debtor and/or pay its debts, and the Debtor has offered to provide evidence to BCO and the court of lenders willing to refinance the Property and pay BCL in full. BCL, however, believes there must be more, that the Debtor must actually be operating and generating cash flow. This argument mistakes both the essential nature of chapter 11 noted above and that, even if being nonoperational would equate to having no on-going business and thereby potentially end the inquiry (which it does not), being nonoperational on a seasonal basis would not.
Among other things, a debtor may, in good faith, use the bankruptcy system to give it a breathing spell to become cash-flow solvent when it is, as the Debtor is in this case, balance-sheet solvent.
In re Bovino, 496 B.R. 492, 507 (Bankr. N.D.Ill.2013) (Barnes, J.). While the Debtor's seasonal business may not be presently operating, that does not mean that there are no assets to operate an on-going business during the peak summer seasons. As a result, this factor is not satisfied.
BCL has also not proven the ninth and twelfth Tekena factors. This is not solely a two party dispute and, as previously demonstrated by the Debtor's schedules, BCL is not the only creditor in this case. Reorganization of the Debtor through confirmation of a chapter 11 plan, thus, may be possible without BCL's consent. See, e.g., 11 U.S.C. § 1129(b). Further, given the undeniable equity in the Property, other forms of chapter 11 relief may be available to the Debtor. Any specific finding on the likelihood of reorganization—and thus, dismissal—under the facts of this case and at this early point in the chapter 11 process, is premature. See Bovino, 496 B.R. at 499 (citing In re Sal Caruso Cheese, Inc., 107 B.R. 808, 817 (Bankr. N.D.N.Y.1989)); see also In re Gen. Growth Props., Inc., 409 B.R. 43, 65 (Bankr.S.D.N.Y.2009) ("There is no requirement in the Bankruptcy Code that a
After considering the foregoing, and after reviewing the facts of Tekena in comparison to those in this matter, the court determines that BCL's reliance on Tekena is misplaced. Some factors were distorted by BCL so as to fit within the facts of this case. Some factors are simply inapplicable. Those that remain, even when taken together, are not enough to establish bad faith.
In fact, this case is very similar to the case of In re Clinton Fields, Inc., 168 B.R. 265 (Bankr.M.D.Ga.1994), which the court finds to be more helpful than Tekena for analyzing the faith of the Debtor in this case. In Clinton Fields, the Debtor's single asset was real property and the case was filed on the eve of foreclosure. Judge Walker did not dismiss the debtor's chapter 11 petition when faced with allegations of bad faith based on findings that "the presence of equity provides both a sound basis for reorganization and substantial evidence of the Debtor's good faith intent to reorganize." Id. at 269.
It is clear to the court, therefore, that BCL has failed to carry its burden that this case was commenced in bad faith and, absent the argument that the Debtor's bankruptcy petition is void, as discussed below, the court finds no cause to dismiss this case under section 1112(b).
As noted above, if the foregoing had been BCL's only allegations, the Motion would have been denied without the need for further inquiry. BCL has also argued, however, that the Debtor's bankruptcy petition was not authorized because one member of the Debtor, BCL, did not approve it. This argument was made in bold and italics in the Motion
Before examining whether the provision requiring BCL's consent contained in the Third Amendment is enforceable under bankruptcy or Michigan law, the court must determine whether such an inquiry is necessary. To put it plainly, if the operating agreement, as amended, does not prohibit the filing as effectuated, then the argument with respect to the validity of the provision is unfounded.
In that regard, BCL argues that the provision in the Third Amendment requiring its consent, as the Special Member of the Debtor, to any material action, including bankruptcy relief, means that the Debtor's petition in this case is invalid because it was filed without its consent.
The Debtor is a limited liability company created in Michigan, therefore, the court must apply Michigan corporate governance law in determining whether the filing was a valid corporate action. See In re Gen-Air Plumbing & Remodeling, Inc., 208 B.R. 426, 430 (Bankr.N.D.Ill. 1997) (Squires, J.) ("The authority to file a bankruptcy petition on behalf of a corporation must derive from state corporate governance law."). In Michigan, "[u]nless the vote of a greater percentage of the voting interest of members is required by this act, the articles of organization, or an operating agreement, a vote of the majority in interest of the members entitled to vote is required to approve any matter submitted for a vote of the members." Mich. Comp. Laws. Ann. § 450.4502(8). Thus, the operating agreement can require more than a majority vote.
The Debtor's original operating agreement provides that "[a]ll members shall be entitled to be vote on any matter submitted to a vote of the members," Operating Agreement for Lake Michigan Beach Pottawattamie Resort, LLC, Article 7.1, p. 7., and that the "affirmative core or consent of a majority of the Sharing Ratios of all the Members entitled to vote or consent on such matter shall be required." Id. at Article 7.2, p. 7. Sharing ratios are defined as the "interests of the respective Members in the total capital of the Company." Id. at Article 4.1, p. 3.
The first and second amendments to the operating agreement shift the sharing ratios between the three individual, original members of the Debtor (first amendment) and add the fourth individual member in exchange for a capital contribution (second amendment), but do not alter the voting requirements. The Third Amendment provides that BCL, as the Special Member, does not have any capital of the Debtor. Third Amendment, Article 12.4(iii), p.2. The four individual members constitute 100% of the sharing ratios, therefore, and consented to the Debtor's bankruptcy petition. But for the specific prohibitions in the Third Amendment, under Michigan law, the Debtor's petition would be authorized as a majority of the sharing ratios consented to the petition in this case.
Those prohibitions, however, change the analysis, and that undoubtedly was their intent.
Article XII of the Third Amendment is entitled "Special Member" and provides:
Third Amendment, Article 12.1, p. 1 (emphasis added). "Section" is not defined in the Third Amendment, but in context clearly refers to Article XII. Article XII is the entirety of the Third Amendment, which was executed in conjunction with the Forbearance Agreement, and establishes BCL as the Special Member and the provision requiring BCL's consent for the Debtor to petition for bankruptcy. Id. at 12.2(viii), 12.3(i), p. 2. Because the Third
The court must, therefore, determine the validity of the prohibitions in the Third Amendment in order to determine whether this petition was authorized under the Debtor's operating agreement and Michigan law and, ultimately, bankruptcy law.
BCL's argument is grounded in the well-established commercial practice of using "blocking directors." A blocking director
The import of such a structure is readily apparent. One specific director, chosen by the secured creditor, may withhold its vote and thus block, hence the name, a voluntary bankruptcy petition. Further, given the limited operations, an involuntary petition against the entity is highly unlikely.
Why go to such effort, one might ask? For one crucial reason: a simpler, absolute prohibition against filing for bankruptcy will likely be deemed void as against public policy. As corporate entities have been held to have, in certain instances, rights akin to that of natural person, see, e.g., Citizens United v. Federal Election Comm'n, 558 U.S. 310, 342, 130 S.Ct. 876, 175 L.Ed.2d 753 (2010), prohibiting such entities from availing themselves of the
Bankruptcy law, however, is equally clear that corporate formalities and state corporate law must also be satisfied in commencing a bankruptcy case. NNN 123 N. Wacker, 510 B.R. at 858. Except in very specific circumstances not at play here,
Put another way, the long-standing policy against contracting away bankruptcy benefits is not necessarily controlling when what defeats the rights in question is a corporate control document instead of a contract.
Nonetheless, common wisdom dictates that the corporate control documents should not include an absolute prohibition against bankruptcy filing.
The consideration of fiduciary duties and public policy concerns further extends to situations where the blocking position is a member of a limited liability company because the member of a limited liability company, such as the Debtor in this case, maintains the power to consent or block a bankruptcy petition. NNN 123 N. Wacker, 510 B.R. at 858 (citing In re Avalon Hotel Partners, LLC, 302 B.R. 377 (Bankr.D.Oregon 2003)).
The essential playbook for a successful blocking director structure is this: the director must be subject to normal director fiduciary duties and therefore in some circumstances vote in favor of a bankruptcy filing, even if it is not in the best interests of the creditor that they were chosen by.
BCL's playbook was, unfortunately, missing this page.
As previously stated, the Third Amendment establishes BCL as the "Special Member" of the Debtor. Third Amendment, Articles 12.2(vii), 12.3(i), p.2. BCL's role as the Special Member may enable it, therefore, to "block" the Debtor from taking any material action, including availing itself of bankruptcy relief, by withholding its required consent. See id. at Article 12.2(vi), p.2. This structure undoubtedly was negotiated by BCL to ensure that the Property was not to be administered in a bankruptcy.
The Debtor's bankruptcy petition was, nonetheless, consented to by the remaining members of the Debtor. The Debtor argues that the consent of the remaining members was sufficient because, despite BCL's insistence to the opposite, the blocking member provision in the Third Amendment is void. As noted above, from a bankruptcy perspective, that conclusion would not be inevitable if fiduciary duties are respected. That is not the case here, however.
Id. at Article 12.4(iv), p. 2-3 (emphasis added). This language results in BCL as the Special Member having no duties to the Debtor,
Under Michigan law, members of a limited liability company have a duty to consider the interests of the entity and not only their own interests. The Michigan Limited Liability Company Act, a subsection of the Michigan Business Corporate Act, much like the corporate governance laws of many other states, requires that
Mich. Comp. Laws Ann. § 450.4404. Therefore, BCL, as a member of a Michigan limited liability company, the Debtor, must consider the interests of the Debtor.
The Third Amendment does provide, however, that these limited duties are allowed "to the fullest extent permitted by applicable law." Third Amendment at Article 12.4(iv), p. 2-3. That savings clause might cure the invalidity of the prohibition, but only by rendering it meaningless. The prohibition has no application other that which is impermissible under Michigan law.
By excluding the Debtor's interests from consideration by BCL when acting as the Special Member of the Debtor, thereby allowing BCL to consider only its own best interests, the Third Amendment also expressly eliminates the only redeeming factor that permits the blocking director/member construct. The Third Amendment provision that BCL's consent was required in order for the Debtor to petition for bankruptcy relief is, therefore, unenforceable, both as a matter of Michigan corporate governance and bankruptcy law.
What the court is left with is this—the blocking member provision of the Third Amendment is void. The remaining corporate governance provisions governing the Debtor, and analyzed in accordance with Michigan law, therefore, result in a valid consent to the Debtor's bankruptcy petition.
For the foregoing reasons, BCL has failed to satisfy its burden of proof as to cause to dismiss the Debtor's bankruptcy petition. Accordingly, the Motion will be DENIED.
A separate Order will be issued concurrent with this Memorandum Decision.
This matter comes before the court on the Motion To Dismiss Case (the "Motion") of BCL-Bridge Funding LLC ("BCL") to dismiss the bankruptcy of Lake Michigan Beach Pottawattamie Resort LLC [Dkt. No. 11]; the court having jurisdiction over the subject matter; all necessary parties appearing at the Hearing that took place from place on January 27, 2016 (the "Hearing"); the court having considered the evidence presented by all parties and the arguments of all parties in their filings and at the Hearing; and in accordance with the Memorandum Decision of the court in this matter issued concurrently herewith wherein the court found that BCL has not satisfied its burden of proof with respect to cause under 11 U.S.C. § 1112(b);
NOW, THEREFORE, IT IS HEREBY ORDERED:
(1) The Motion is DENIED.
Gen. Growth, 409 B.R. at 49.
