Opinion
Case No. 97-13993-SSM
March 19, 1999
Richard Morsell, Federal Supply Contracts Group, Chantilly, VA, for Debtor in possession
Joel Steinberg, Esquire, Joel Steinberg Associates, Fairfax, VA, of Counsel, for the debtor in possession
MEMORANDUM OPINION AND ORDER
A hearing was held in open court on December 8, 1998, on (a) the motion filed by the United States Trustee on July 30, 1997, to dismiss or convert this chapter 11 case and (b) the debtor's motion of November 19, 1998, to extend the time to file a plan. At the conclusion of the hearing, the court took both motions under advisement in order to review the file.
The title of the motion is something of a misnomer, since what the debtor is seeking is an extension of the November 30, 1998, deadline by which it was required to obtain confirmation of a plan.
Facts
Federal Supply Contracts Group, Inc., is in the business of supplying furniture to government agencies. It filed a voluntary chapter 11 petition in this court on May 29, 1997, and has continued to operate since that date as a debtor in possession. The debtor has proposed three plans, none of which have been confirmed.
The most recently filed of these is entitled Third Amended Plan of Reorganization and is dated December 7, 1998. The disclosure statement accompanying the plan has never been set on the court's hearing calendar for approval. The plan itself contemplates the liquidation of the debtor, with the winding down of business operations to commence on December 1, 1998, and to be completed by March 31, 1999. Two taxing authorities have filed objections to confirmation. Subsequent to the December 8th hearing, the court was advised by counsel for the debtor that the debtor intended to file a further modified plan; however, no such modified plan has been filed as of the date of this opinion.
The president and majority (75%) shareholder is Richard A. Morsell, Jr. His wife owns the other 25% of the shares but apparently does not participate in the operation of the business. His daughter, Lori Morsell, is the corporate secretary and currently the only other full-time employee. The schedules in this case reflect $1,224,464 in unsecured claims. As amended, the schedules also reflect that the debtor had $806,242 in accounts receivable, of which $621,754 were pledged to a factor. The remaining $184,488.09 in pre-petition accounts receivable were subject to claimed UCC security interests in favor of Lawrence Lerner and Lawrence Schwartz. Mr. Lerner filed a proof of claim in the amount of $185,341, while Mr. Schwartz filed a proof of claim in the amount of $39,115. Mr. Morsell is personally liable on both obligations.
If the statement of financial affairs is to be believed, the debtor at one time enjoyed a booming business, grossing $8,509,852 in 1995 and $9,840,573 in 1996. Monitoring the financial performance of the business during the nearly 20 months it has been in chapter 11 has been notably difficult because of the debtor's consistent failure to file accurate and timely monthly financial reports as required by the standard order entered in this case on July 9, 1997, conditioning the rights of the debtor in possession. A number of the reports have had to be amended, some more than once. For the period for which reports do exist (June 1997 through October 1998), the debtor showed an operating profit in only 6 of the 17 months and losses in the remaining 11. The cumulative loss over the 17-month period was $43,014. No reports have been filed for November 1998 or subsequent months. Gross revenues for the 17-month period were $1,065,757, which equates to $752,299 on an annualized basis — less than one-tenth of the annual gross reported in 1995 and 1996.
Under the order conditioning rights of debtor in possession, the reports for each month are due on the 15th day of the following calendar month.
Approximately two months into the case, the United States Trustee brought a motion to convert or dismiss. Following an evidentiary hearing, the court, by order dated September 30, 1997, denied the motion but directed the debtor to reduce Mr. Morsell's salary to $90,000 a year, to file a plan and disclosure statement by December 1, 1997, to amend the schedules, and to file corrected monthly operating reports. Several subsequent status hearings have been held, at many of which the United States Trustee has renewed the request for dismissal or conversion. Each time the case has come up for a status conference, the court has allowed the debtor to remain in chapter 11 based on the debtor's rosy income projections and the representation that the debtor was proceeding diligently toward confirmation. At the most recent status conference, the court, although again denying the motion to convert or dismiss, ruled that the debtor would be required to obtain confirmation of a plan by November 30, 1998, or the case would be converted or dismissed. This ruling was embodied in an order dated July 29, 1998, which also set a further status hearing for December 8, 1998, to determine the debtor's compliance.
The original schedules reported that the debtor had no accounts receivable.
These were held on November 9, 1997; January 20, 1998; March 17, 1998; March 24, 1998; April 14, 1998; May 19, 1998; June 16, 1998; June 30, 1998; and July 27, 1998.
For example, at the July 27, 1998, hearing, the court had available financial reports through June 1998. Although the debtor had shown losses in 8 of the 13 months it had operated post-petition and had cumulative post-petition losses at that point of $33,394, it had shown a profit in the most recent month, and a trend-line analysis reflected that the debtor's profitability was slowly improving. It was represented that the debtor had substantial orders on hand, and that September, October, and November were historically very good months for the debtor because of the heavy volume of buying by Federal agencies at the close of the Federal fiscal year. The debtor did in fact post a modest profit in July 1998, but then posted losses in August, September, and October 1998.
Discussion
Dismissal or conversion of a chapter 11 case is governed by § 1112, Bankruptcy Code, which provides in relevant part as follows:
(b) [O]n request of a party in interest or the United States trustee and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interest of creditors and the estate, for cause, including —
(1) continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation;
(2) inability to effectuate a plan;
(3) unreasonable delay by the debtor that is prejudicial to creditors;
(4) failure to propose a plan under section 1121 of this title within any time fixed by the court; [and]
(5) denial of confirmation of every proposed plan and denial of a request made for additional time for filing another plan or a modification of a plan[.]
The listed grounds are illustrative, not exclusive. § 102(3), Bankruptcy Code; In re Gonic Realty Trust, 909 F.2d 624, 626 (1st Cir. 1990); see also Trident Assocs. L.P., 52 F.3d 127, 131 (7th Cir. 1994) ("cause" for dismissal must be determined on case-by-case basis after considering totality of the circumstances). At bottom the court is required to balance the legitimate need of the debtor for time to reorganize its financial affairs against the detriment to the creditors from allowing the debtor to remain in chapter 11. In this case, the debtor has provided no compelling reason for its failure to comply with this court's order of July 29, 1998, setting a confirmation deadline of November 30, 1998. The debtor's sole explanation for the delay is that it did not learn until mid-October that it had not been awarded certain contracts on which it had bid. The plan it now seeks to have confirmed is little more than a blueprint for a three-month going-out-of-business sale. It is true that chapter 11 does not necessarily require that a business continue in operation after plan confirmation, and that a debtor is free to propose a plan that provides for a controlled liquidation of its assets. § 1123(b)(4), Bankruptcy Code; In re Alves Photo Service, Inc., 6 B.R. 690 (Bankr. D. Mass. 1980) (denying motion to convert solely because chapter 11 trustee had sold essentially all the debtor's property, where there was no evidence of loss or diminution of the estate during the trustee's administration). Such a plan may, indeed, have a particular appeal to creditors where the assets consist primarily of accounts receivable, since the debtor may be in a better position to collect them than would a chapter 7 trustee.
It also proposes to pay only 25% of the filed priority tax claims.
At the same time, the ordinary and preferred mode of liquidation is chapter 7. See In re Pedro Abich, Inc., 165 B.R. 5, 9 (D. P.R. 1994) ("Where a debtor's plan is a liquidation rather than a reorganization, conversion may be proper"). Because of the greater administrative costs typically incurred in chapter 11, a court should look skeptically upon chapter 11 as a vehicle for liquidation unless there is a strong showing that the creditors are likely to be better off with the debtor overseeing its own liquidation. In re L. S. Good Co., 8 B.R. 310, 311 (Bankr. N.D. W. Va. 1980). Where there is no benefit to creditors, but only to the debtor or its insiders, generally there will be little reason to allow the case to remain in chapter 11.
In the present case, it has become increasingly clear that the motivation for the debtor's continued business operations has not been to generate a dividend for unsecured creditors but rather to provide a salary to Mr. Morsell and his daughter and, perhaps more importantly from Mr. Morsell's perspective, to pay off the two secured creditors, Mr. Lerner and Mr. Schwartz, whose notes he has personally guaranteed. Unquestionably, those two creditors have benefitted from the debtor's continued operations. The third amended disclosure statement states that Mr. Schwartz has been paid in full as a result of payments made during the course of the chapter 11, and that the debt to Mr. Lerner has been substantially paid down. It is less clear, however, that both creditors are — as the debtor has treated them — fully secured. The aggregate amount of their claims exceeds by $39,968 the pre-petition accounts receivable not otherwise pledged. Thus, payments to them may have been made at the expense of unsecured creditors. See In re Nelco, 210 B.R. 707, 709-10 (Bankr. E.D. Va. 1997) (conversion from chapter 11 to chapter 7 appropriate in part because chapter 7 trustee would be in a better position to exercise independent judgment in pursuing claims on behalf of the bankruptcy estate). Of course, not every liquidation, whether in chapter 7 or chapter 11, results in a dividend to unsecured creditors. Sometimes, the amount of secured or priority unsecured claims will exceed the available assets, with the result that unsecured creditors receive nothing. Accordingly, the fact that nothing will likely be available for unsecured creditors in this case does not, standing alone, dictate conversion. The lack of benefit to unsecured creditors, however, coupled with the substantial post-petition losses incurred by the debtor, the long period of time (20 months) the debtor has been in chapter 11, the failure to comply with the deadline set by this court for achieving confirmation, the consistent tardiness in filing monthly financial reports, the failure to file any financial reports for the last four months, and the desirability of having a trustee examine the payments made to Messrs. Lerner and Schwartz, all weigh in favor of conversion to chapter 7 as being in the best interest of creditors
As of October, 1998, the last month for which financial reports have been filed, Mr. Morsell was being paid $7,500 per month and Lori Morsell $3,750 per month. Additionally, the debtor incurred $1,321 in premiums for their medical insurance. In that month, the debtor's operating loss was $13,079.
ORDER
For the foregoing reasons, it is
ORDERED:
1. The debtor's motion for further extension of time to file a plan of liquidation — which the court treats as a motion for extension of the deadline set by the order of July 29, 1998, to achieve confirmation of a plan — is denied.
2. The United States Trustee's motion to dismiss or convert is granted, and this case is converted to a case under chapter 7 of the Bankruptcy Code.
3. The clerk shall mail a copy of this order to the debtor in possession, counsel for the debtor in possession, and to counsel for the United States Trustee, and shall give all creditors and parties in interest notice of the conversion of the case.