ERIC L. FRANK, Chief Judge.
In this individual chapter 11 bankruptcy case an unsecured creditor, has filed a "Motion for an Order Directing the Appointment of a Chapter 11 Trustee or Examiner or the Conversion of the Case" ("the Motion"). The debtor contests the Motion.
During the course of the litigation of this contested matter, all parties agreed that neither the appointment of a trustee nor dismissal of the case is appropriate. Thus, the issue is whether the case should be converted to chapter 7 or remain in chapter 11 to permit the debtor the opportunity to confirm a plan of reorganization.
For a variety of reasons, the creditor maintains that "cause" exists under 11 U.S.C. § 1112(b)(1) for conversion of this case to chapter 7. The debtor disputes this, but contends alternatively, that even if "cause" exists, "unusual circumstances," within the meaning of 11 U.S.C. § 1112(b)(2) are present and that it is in the best interests of creditors that this case remain in chapter 11.
As explained below, I conclude that cause exists for the relief requested under § 1112(b)(1) and that the debtor has not established the existence of unusual circumstances within the meaning of § 1112(b)(2). Accordingly the Motion will be granted and this case will be converted to chapter 7.
Scott Korn ("the Debtor") filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code on April 21, 2014. The Debtor engaged Klehr Harrison Harvey Branzburg LLP ("Klehr Harrison") to represent him. He filed his initial set of bankruptcy schedules and statements on May 2, 2014. The § 341 meeting of creditors was held and concluded on June 3, 2014.
On July 11, 2014, the Debtor filed a proposed chapter 11 plan of reorganization ("the Initial Plan") (Doc. #92), a proposed Disclosure Statement ("the Initial DS") (Doc. #93) and a motion for approval of the DS ("the DS Motion") (Doc. #94). A hearing on the DS Motion was scheduled initially on August 20, 2014 and then continued to October 1, 2014. In the interim, the Debtor filed an Amended Plan and an Amended DS on August 29, 2014. (Doc. #s 129 & 130).
On July 18, 2014, John Brown ("Brown"), an unsecured creditor, filed a Motion for an Order Authorizing Discovery and Examinations of the Debtor and Non-Debtors Pursuant to Fed. R. Bankr. P. 2004. (Doc. #102). Brown's Rule 2004 Motion was granted on July 28, 2014. (Doc. #114).
On September 24, 2014, another creditor, American Express Bank FSB
On September 25, 2014, the day after AmEx filed its adversary complaint, the Debtor filed an application to employ new bankruptcy counsel, Maschmeyer Karalis, P.C. ("M & K"), and sought expedited consideration of the application. (Doc. #149). On the same day, also on an expedited basis, the Debtor filed an application to retain Asterion, Inc. ("Asterion") as a valuation expert to assist the Debtor in preparing projections, a liquidation analysis, a valuation report with respect to the Debtor's business interests and to provide expert testimony. (Doc. #153). After a hearing, the court granted both applications. (See Orders dated October 15, 2014) (Doc. #185, 189).
On October 1, 2014, while its application for appointment was pending, M & K advised the court that it intended to amend the initial bankruptcy schedules and revise substantially the amended chapter 11 plan and amended disclosure statement. Consequently, the court continued the hearing on the DS Motion to January 7, 2015.
On November 10, 2014, the Debtor filed amended Schedules and an amended Statement of Financial Affairs (collectively, "the Amended Schedules"),
On November 18, 2014, the Debtor filed another amended plan ("the Second Amended Plan") and disclosure statement ("the Second Amended DS"). (Doc. #'s 237, 237).
On October 6, 2014, less than two (2) weeks after the AmEx Complaint was filed, Brown filed the Motion. (Doc. #178). With new counsel, the Debtor filed a response to the Motion on October 31, 2014. (Doc. #201).
The court held an evidentiary hearing on the Motion on November 19 and 24, 2014. Two (2) witnesses testified: (1) the Debtor and (2) Asterion's principal, Stephen J. Scherf, CPA, who testified as an expert valuation witness.
Brown, the Debtor and the UST all submitted post-hearing memoranda in support of their positions, the last of which was filed on December 8, 2014.
I make the following findings of fact based upon the testimonial and documentary evidence presented at trial. In making these findings, I have considered the demeanor of the witnesses, the plausibility of their testimony, the existence of corroborating circumstantial, testimonial or documentary evidence and the totality of the evidentiary record.
1. The Debtor is an individual who resides at 1233 Meadowbank Road, Villanova, Pa ("the Residence"), with his spouse, Arlene Korn, and three (3) children, ages 20, 19 and 16. (Ex. Brown-6, Schedule J).
2. The Debtor owns two (2) pieces of real property (collectively, "the Properties") with his spouse as tenant by the entireties:
3. The Debtor claims he does not know the current value of either of the Properties. (Id.).
4. The Residence is subject to two (2) mortgages securing debts in excess of $4 million:
(Id., Scheduled D).
5. The Lake Harmony Property is subject to three (3) mortgages, securing debts of almost $500,000.00.
6. The Debtor has disclosed an interest in personal property, including but not limited to:
(Id., Schedules B, D).
7. According to the Amended Schedules, the aggregate value of the Debtor's interest in personal property is almost $2.65 million. (Id., Schedule B).
8. The Debtor has claimed as exempt, personal property totaling more than $1.6 million in value. (Id., Schedule C).
9. The Debtor holds an interest in more than twenty (20) business entities, all of which he valued as either $0.00 or unknown. (Id., Schedule B).
10. At least three (3) of those business entities are active and provide the Debtor with most of his current personal income: Bengal Converting Services, Inc. ("Bengal"), Monterey Leasing, L.P. ("Monterey")
11. Bengal is in the business of paper sales and converting services and has been operating since 1993. (Debtor's Testimony; Ex. D-2 at ¶ 6.1).
12. Korn Group owns the building in which Bengal Operates. (Debtor's Testimony; Ex. D-2 at ¶ 6.1).
13. Monterey leases equipment to Bengal. (Debtor's Testimony; Ex. D-2 at ¶ 6.1).
14. Since the commencement of the bankruptcy case, the Debtor has been drawing approximately $15,000.00 per month from his businesses. (See Exs. 15 to B-20).
15. In addition, the Debtor's spouse draws a net salary from Bengal of approximately $3,200.00 per month. (Ex. Brown-6; Debtor's Testimony).
16. The Debtor's monthly expenses total approximately $17,350.00, including:
17. In December 2009, the Debtor, his spouse and a number of his business entities, including Bengal and Monterey, were named as defendants in a lawsuit brought by John Brown in the Court of Common Pleas, Philadelphia County, docketed at No. 09-12-02419.
18. On April 9, 2014, a jury returned a verdict in favor of Brown and against the
19. The entry of the Brown Jury Verdict precipitated the Debtor's bankruptcy filing on April 21, 2014. (Plan ¶ 6.4).
20. In the twelve (12) day period between the entry of the Brown Jury Verdict and the filing of his chapter 11 bankruptcy petition, the Debtor used his three (3) separate AmEx credit card accounts to make more than $365,000.00 in purchases, including:
21. The Debtor titled the vehicles in joint names with his spouse.
22. The Debtor filed his initial set of bankruptcy schedules ("Initial Schedules") and statements on May 2, 2014.
23. In his Initial Schedule B, the Debtor failed to disclose his interest in, inter alia:
24. In his Initial Schedule F, the Debtor failed to disclose the existence of a number of creditors holding claims exceeding $1.5 million, including, inter alia:
(Compare Ex. Brown-2, Initial Schedule F with, Brown-6, Schedule F).
25. In the his initial Statement of Financial Affairs ("Initial SOFA"), the Debtor failed to disclose certain pre-petition asset transfers, including, inter alia:
(Compare Ex. Brown-3, Initial SOFA with, Brown-7, Amended SOFA).
26. After commencing his bankruptcy case, the Debtor continued to use his AmEx credit cards, incurring more than $150,000.00 in charges, largely for business expenses of Bengal. (Ex. Brown-24).
27. These charges are not shown as accounts receivables or loans from the Debtor to Bengal on his monthly operating reports.
28. On May 9, 2014, the Debtor liquidated a brokerage account and paid off the claim of Meridian Bank that was secured by the brokerage account.
29. The Debtor liquidated the account and paid off the pre-petition debt without notice to any party in interest and without court approval.
30. As a result of the liquidation of the brokerage account and the satisfaction of the Meridian secured debt, the Debtor received net proceeds of approximately $214,000.00 in the form of cash.
31. Rather than place the $214,000.00 in a debtor-in-possession account, the Debtor placed the cash in his safe.
32. On May 9, 2014, the Debtor filed an Application to Employ Archer Tax & Financial Group, P.C. ("the Archer Group") as his accountant in this chapter 11 case. (Doc. #57).
33. The application was granted by order dated May 21, 2014, which provided that "Archer [is] to be paid at such compensation as the Court shall allow, only after approval of an application in accordance with In re Busy Beaver, 19 F.3d 833 (3d Cir.1994)." (Doc. #72).
34. In April and May 2014, the Debtor paid the Archer Group compensation of $4,000.00, (see Ex. Brown-24, Account-2006 at 4-5), without prior court approval in violation of the terms of the court's appointment order and the Bankruptcy Code. (See Doc. #72; 11 U.S.C. §§ 330, 331).
35. Although the Archer Group was authorized to act as the Debtor's accountant in this chapter 11 case, the Debtor has not been using its services. Instead, Frank
36. On October 29, 2014, a few weeks after Brown filed the Motion, the Debtor closed his safe deposit box. (Ex. B-7, ¶ 12).
37. No one accompanied the Debtor to the bank when he did so.
38. The Debtor attended the § 341 hearing on June 3, 2014.
39. At the § 341 hearing, when directly asked whether he owned any vehicles other than the 2000 Harley Davidson, see Finding of Fact No. 23.f. & n. 16, supra, the Debtor denied owning any automobiles.
40. On June 11, 2014, the Debtor filed the Initial Plan and the Initial DS.
41. On August 29, 2014, the Debtor filed an Amended Plan and an Amended DS.
42. The Initial Plan, Amended Plan, Initial DS and Amended DS all also omitted the disclosure of assets, debts and pre-petition transfers described in Findings of Fact Nos. 23-25.
43. The Debtor did not correct most of the omissions in his bankruptcy schedules until November 10, 2014, when he filed amended schedules and an amended Statement of Financial Affairs. (see Doc. #'s 209-10).
44. The Debtor corrected the omissions in the Initial Plan, Amended Plan, Initial DS and Amended DS when he filed the Second Amended Plan and the Second Amended DS on November 18, 2014. (See Doc. #'s 236-237).
45. The Debtor made the corrections of the omissions only after the Amex Complaint brought some of the deficiencies to light and after Brown filed the Motion.
46. The main elements of the Initial Plan, as amended on August 29, 2014, (Doc. #129) were as follows:
47. The main elements of the Second Amended Plan, filed with the assistance of the Debtor's new counsel, M & K, on November 18, 2014, (see Doc. #236), are as follows:
48. The Debtor acted either intentionally or recklessly in filing schedules and statements that had massive omissions.
Brown seeks conversion of this chapter 11 case to chapter 7 pursuant to 11 U.S.C. § 1112(b). Section 1112(b) provides, in pertinent part:
Application of § 1112(b) is a two-step process. The initial burden is on the movant to prove by a preponderance of the evidence that there is "cause" for either conversion or dismissal of the chapter 11 case, whichever is in the best interests of creditors and the estate. Once cause is found, the burden shifts to the opposing party to show why dismissal or conversion would not be in the best interests of the estate and the creditors.
The Code provides sixteen (16) examples of "cause" for relief under § 1112(b) in § 1112(b)(4).
The court's determination regarding the existence of cause under § 1112(b)(1) is a factual inquiry in which the court may exercise its discretion.
Under § 1112(b)(2), the court retains discretion in evaluating whether there are "unusual circumstances" that establish that conversion or dismissal "is not in the best interests of creditors and the estate."
When all of the elements of § 1112(b)(2) are broken down and aggregated, § 1112(b)(2) defense to conversion or dismissal of a chapter 11 case actually consists of six (6) components:
In this case, my conclusion that there is "cause" for relief under 11 U.S.C. § 1112(b)(1) is predicated largely on my finding that the Debtor acted either intentionally or recklessly in violating his financial disclosure obligations as a chapter 11 debtor. (See Finding of Fact No. 47).
The Debtor offered two (2) explanations for the glaring omissions from his initial bankruptcy schedules and statements. Initially, he tried to blame his former counsel, Klehr Harrison for either failing to properly counsel him regarding the required disclosures or failing to include all of the information in the schedules that he provided to counsel in the preparation process prior to their filing. (Even with this explanation, he admitted that he did not carefully review the schedules and statements before he verified them). However, the Debtor withdrew this asserted excuse after it became clear that blaming counsel would open the door to scrutiny of his communications with counsel.
Withdrawal of the "reliance on counsel" theory left the Debtor with one other explanation for his failure to comply with his statutory duty under 11 U.S.C. § 512(a)(1). While his actual testimony was not especially articulate, he suggested that an anxiety disorder, exacerbated by (1) the shock he suffered when the Brown Jury Verdict was entered and (2) time constraints in the preparation of the bankruptcy schedules and statements, prevented him from paying the necessary attention to detail to insure that the disclosures were substantially accurate.
As finder of fact, I do not find the Debtor's explanation credible for many, independent reasons, including:
On this record, once the Debtor's excuse is disregarded, I may infer that the Debtor deliberately failed to disclose material information from his creditors when he filed his bankruptcy schedules and statements. However, to decide the Motion, I need not go so far. At a minimum, his conduct was reckless. See generally Bullock v. BankChampaign, N.A., ___ U.S. ___, 133 S.Ct. 1754, 1757, 185 L.Ed.2d 922 (2013) (for purposes of 11 U.S.C. § 523(a)(4), a debtor acts recklessly by consciously disregarding or willfully turning a blind eye to a known risk that his or her conduct will violate a fiduciary duty).
Given my factual finding regarding the Debtor's scienter, I conclude easily there is "cause" to convert the case under § 1112(b)(1).
The Debtor, while acting as debtor-in-possession ("DIP") and as a fiduciary to his creditors,
Considering both the nature and number of improprieties here, the conclusion is inescapable that the Debtor had no appreciation of his fiduciary obligations as a chapter 11 debtor. His conduct fell woefully short of the standards expected of a bankruptcy fiduciary, making it clear that "cause" exists for relief under § 1112(b)(1).
The term "unusual circumstances" is not defined in the Bankruptcy Code. Many courts have stated that "unusual circumstances" under § 1112(b)(2) involve "conditions that are not common in most chapter 11 cases."
My review of the case law suggests that "unusual circumstances" is largely "result oriented," a term I do not employ in any pejorative sense in this context. I use the term to suggest only that, under § 1112(b)(2), courts focus on the likely consequences of remaining in chapter 11 or converting the case to chapter 7 and consider what the likely differences would be in the end result under each chapter. Notwithstanding the existence of "cause" for conversion or dismissal of the case, if the likely outcome for creditors will be vastly superior under chapter 11, courts may find unusual circumstances under § 1112(b)(2).
In this case, for two (2) independent reasons, I conclude that Debtor did not satisfy the standards under 11 U.S.C. § 1112(b)(2) to avoid conversion or dismissal.
Section 1112(b)(2) requires that there be a "reasonable justification" for the act or omission that gives rise to a finding of "cause" under § 1112(b)(1). I have rejected entirely the Debtor's explanation for his unacceptable financial reporting.
Further, and more fundamentally, the Debtor has not established that this is case is unusual in either common meaning of the term or in the specialized way it is employed in § 1112(b)(2), such that it would be appropriate to disregard the existence of cause of conversion of the case.
The Debtor's bankruptcy filing was precipitated by the Brown Jury Verdict. Chapter 11 filings regularly occur after a major litigation setback. There is nothing unusual about that.
Further, the fact that the Motion was precipitated and is grounded in difficulties of the Debtor's own making — his failure to comply with the financial reporting requirements of the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure — cannot be characterized as unusual. The plethora of reported cases under § 1112(b)(4)(F) makes that clear enough.
But perhaps most importantly, the Debtor has not demonstrated that chapter 11 is certain enough to provide a relatively risk-free, clear path to a materially superior result for creditors than a conversion to chapter 7.
In the Second Amended Plan and Second Amended DS, the Debtor proposes to treat Ocwen's $3.5 million secured claim in a manner that is not clearly comprehensible.
The proposed treatment of the second mortgage on the Residence is equally problematic. The Second Amended Plan provides that if Fidelity makes the § 1111(b) election, it will be paid from the net proceeds from the sale of the Residence. However, if the property is to be sold, there is nothing in the record to indicate that there will be any net proceeds after Ocwen is paid. As a result, this Plan provision is peculiar and illogical.
The devotion of almost 60% of the Debtor's net income to debt service, insurance and taxes on the Debtor's real property (exclusive of his $3.5 million first mortgage on the Residence]). combined with his failure to address the Ocwen claim in a realistic manner, creates a strong impression that the Debtor's plan is either a visionary scheme with little chance of success
Separate and apart from the concerns arising from the Debtor's proposed treatment of the Residence and the claims against it, the Plan's feasibility is questionable. The Plan funding is based largely on distributions that the Debtor expects to receive from his business entities over a five (5) year period. The reliability of this revenue source is not sufficiently clear to establish that the interest of creditors are better served under chapter 11 rather than chapter 7. As Brown pointed out in his post-hearing brief,
Finally, the foundation of every chapter 11 reorganization case is that acceptance of the Debtor's plan is in the best interests of the creditors as compared to a chapter 7 liquidation because their distribution is projected to be greater under chapter 11. An unusual case would be one in which the disparity between the outcomes of the different chapters is stark and substantial. Here, even if successful, the Plan does not provide a compelling result for unsecured creditors. It proposes a distribution to unsecured creditors of less than one-half of one percent (0.4213%) on the effective date and a total of less than seven percent (6.8%) to creditors over five (5) years. This relatively meager proposed distribution does not support a finding of "unusual circumstances" under § 1112(b)(2). The pedestrian level of benefits promised to creditors in chapter 11 combined with the feasibility issues that exist, convince me that the Debtor has not met his burden of proving unusual circumstances under § 1112(b)(2).
This is a case in which an individual debtor has attempted to use the chapter 11 process to salvage and maintain his pre-petition lifestyle to the greatest extent possible, while paying his creditors the minimum amount he believes is necessary to convince them to support his chapter 11 plan. By themselves, there is nothing necessarily wrong or unusual about either of those goals. However, in his attempt to obtain the best possible financial rehabilitation, the Debtor abused the chapter 11 process by concealing material information from his creditors. And, even after doing so, either because he is persisting in his effort to maximize his financial rehabilitation or because he is genuinely incapable of offering creditors a better plan, the
At the risk of oversimplification, several courts have observed that § 1112(b)(2) may be invoked when "unusual facts or circumstances demonstrate that the purposes of chapter 11 would be better served by maintaining the case as a chapter 11 proceeding."
For these reasons, the Motion will be granted and this case will be converted from chapter 11 to chapter 7. An appropriate order follows.
It is hereby
1. The Motion is
2. This case is
(Amex Complaint ¶¶ 16, 20, 61-62).
The attorney for another creditor, Citibank, which (according to the Debtor's Amended Schedule F holds an unsecured claim of $5.25 million), attended the hearing on the Motion as an observer. At the conclusion of the hearing, Citibank's attorney advised the court that it, too, opposed the appointment of a trustee or conversion of the case.
Thus, the parties opposing the Motion hold scheduled claims totaling just under $6.9 million, more than one-half of the total amount of general unsecured claims listed in the Amended Schedule F is approximately $11.8 million. Brown's claim (disputed by the Debtor) is $2.4 million.
Obviously, there is some meaningful support for the Debtor's position in the creditor constituency. However, the significance of this creditor support is diluted by the facts that JN Holding Services appears to be an insider and Citibank's claim is a guaranty claim that is secured by assets of another business entity or entities.
The DS describes Korn Group I as an entity that "rent[s] commercial space," (presumably in same building in which Bengal operates). The Debtor does not disclose any personal income as derived from that entity.
Curiously, even though MLGP is described in the DS (as well as in Debtor's Amended Schedule B (Ex. Brown-6)) as an operating entity, the DS does not describe its function. Nor has the Debtor disclosed any income as being derived from MLGP. The Debtor reference the entity in his testimony.
The state court docket also reflects that the CP court granted the defendants' motion for a nonsuit at trial with respect to claims for fraud and unjust enrichment and that the jury verdict was based on a breach of contract theory. (Ex. Brown 22, at 22). The state court docket does not indicate that the Brown Jury Verdict drew any distinction among the defendants. Thus, it appears that the verdict also was entered against Bengal, Monterey and the Debtor's spouse.
(Ex. Brown-40, at 35-36) (emphasis added).
(Plan ¶ 5.3) (Doc. #236).
(Ex. Brown 49, at 234-25) (emphasis added).
While it is not necessary to ground the finding of "cause" in a specific subsection of § 1112(b)(4), see n. 22 & accompanying text, supra, the Debtor's failure to provide accurate schedules and statements falls under § 1112(b)(4)(F) as an unexcused failure to satisfy timely any filing or reporting requirement. Simply filing the correct form on time is not compliance with § 1112(b)(4)(F), at least where the timely filed documents contain grossly erroneous, material information. "Filing a piece of paper is meaningless if the content is inaccurate, misleading, or wrong, thus the content of these documents is ... relevant [under § 1112(b)(4)(F)]." In re Tucker, 411 B.R. 530, 532 (Bankr.S.D.Ga.2009); see also In re Charles Street African Methodist Episcopal Church of Boston, 499 B.R. 66, 115-16 (Bankr.D.Mass.2013); In re Hoyle, 2013 WL 210254, at *6-7 (Bankr.D.Idaho Jan. 17, 2013); In re Whetten, 473 B.R. 380, 383 (Bankr.D.Colo.2012); In re Sanders, 2010 WL 5136192, at *4 (Bankr.D.S.C. Apr. 29, 2010).
Perhaps this reflects a pessimistic view of the results usually achieved in most chapter 11 cases. Regardless whether this glum perception of chapter 11 outcomes is empirically valid, it appears to drive the treatment of § 1112(b) contested matters.
To be clear, if the request for conversion in this case were based solely on the absence of a reasonable likelihood of a debtor being able to propose a feasible, confirmable plan, see e.g., In re 3 Ram, Inc., 343 B.R. 113, 117-18 (Bankr.E.D.Pa.2006), it is not obvious that cause for conversion would exist. At least at a relatively early stage of a case, the problems I have described in a plan such as the Debtor's Second Amended Plan might be remediable. But, once cause for conversion has been established for other reasons, to find "unusual circumstances" under § 1112(b)(2), the Debtor must make a stronger showing of the presumptive benefits, feasibility and confirmability of its proposed plan for reorganization.
