Opinion
Case No. 09-10083.
6-12-2009
In Re FRITZSCH CUSTOM BUILDERS, LLC, Chapter 11, Debtor.
Thomas and Suzanne Nies, creditors of this estate, have filed the instant motion ("Motion") (Doc. 22) seeking to dismiss the chapter 11 case filed by the Debtor, Fritzsch Custom Builders, LLC. The Motion is governed by 11 U.S.C. § 1112(b)(1), which states that "the court shall convert a case under this chapter to a case under chapter 7 or dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, if the movant establishes cause." Under the applicable law, dismissal is warranted if the movant has shown that "cause" exists and that, in the bankruptcy judge's opinion, dismissal rather than conversion to chapter 7 is in the best interest of creditors and the estate.
FACTS
The Debtor is a custom builder that possesses three assets: (1) a 2002 van with a scheduled value of $2,500; (2) a newly constructed custom home overlooking the Ohio River, appraised from $630,000 to $1,100,000 in its current condition; and (3) state law claims for monetary relief against a surveyor and an insurance company. The Debtor concedes that it no longer operates an ongoing construction business, does not generate any income, and wants to use chapter 11 solely to liquidate the assets of the estate rather than reorganize.
I. 3025 Ononta and the View Easement
The chapter 11 case was precipitated by a divisive and protracted lawsuit in state court arising from the construction of the Debtor's custom home, located at 3025 Ononta Avenue, Cincinnati, Ohio. Mr. and Mrs. Nies own the home next door. 3025 Ononta is subject to a view easement that benefits the Nies property. The easement prohibits the owner of 3025 Ononta from occupying certain airspace above the property so that the owner of the property where the Nieses currently reside may enjoy an unobstructed view of the Ohio River. When the Debtor built 3025 Ononta, it inadvertently encroached upon the Nieses' property's easement.
II. State Court Litigation
The issue was litigated extensively in state court. An appeal has been lodged by the Debtor from an adverse decision rendered against it. There are three principal components to the state court proceedings.
The Debtor also filed a motion, pursuant to 11 U.S.C. § 362(d), seeking to modify the automatic stay (Doc. 39) so that the Debtor can pursue an appeal in state court. Thomas Nies filed a response (Doc. 46) to the motion. By separate order entered in this case, the motion to modify the stay will be granted.
A. Vertical Encroachment
One of the issues was whether the easement applied only to airspace above 631.30 feet over sea level. If so, then two decks attached to the home below 631.30 would not have violated the easement. The trial court concluded that the easement did not have a 631.30 floor, as argued by the Debtor, and ordered removal of the decks and their footers. The decks and footers are no longer part of the home.
B. Horizontal Encroachment
Following the trial court's legal determination concerning the vertical parameters of the easement, a jury awarded damages to the Nieses for a horizontal encroachment of approximately 3.5 feet. The Debtor does not dispute the horizontal encroachment or the amount of the jury award for $166,000 owed the Nieses.
C. Attorney's Fees
Lastly, the trial court ordered the Debtor to pay for the Nieses' attorney's fees, being approximately $92,000.
III. Chapter 11 Strategy — Maximize Value Through Litigation
The Debtor concedes that this is a liquidating chapter 11. According to the Debtor, its strongest motivation for filing this case is to maximize the dividend to unsecured trade creditors it has done business with over the years. Of concern, however, is that the Debtor intends to accomplish this through litigation, rather than a reorganized home building business with restructured debt, a revamped business plan and perhaps some new investors. Specifically, the Debtor wants to pursue four lawsuits to fund a chapter 11 plan. Until the Debtor prevails in these various pieces of litigation, there is no other money available to keep the Debtor afloat other than the payments Robert Fritzsch, the Debtor's principal, is making on the quarterly U.S. Trustee fees and utilities at 3025 Ononta.
A. Appeal of State Court Decision
First, and foremost, the Debtor has appealed the state court decision concerning: (1) the finding of vertical encroachment; and (2) the award of attorney's fees. If the state appellate court determines that the easement does not extend below 631.30 over sea level, the Debtor believes that the value of the property will be greatly enhanced because: (1) the decks would be reinstalled; and (2) the owner would possess unrestricted use and enjoyment of the yard. In addition, if the appeals court reverses the attorney's fees award, the secured claims against the estate will be reduced by $92,000.
Given the state trial court's construction of the easement, the Debtor contends that the owner of 3025 Ononta cannot plant flowers or place a lawn chair in the yardspace subject to the easement.
B. Action Against Surveyor
The Debtor would also like to initiate a state court action against the professional it hired to survey 3025 Ononta. The Debtor believes that the surveyor should have discovered a second easement recorded in 1991 from public records and notified the Debtor of it before construction began. Based on the surveyor's alleged negligence, the Debtor contends that it will recover monetary damages for $166,000, the amount the jury awarded to the Nieses for the horizontal encroachment. According to the Debtor, once these funds are recovered they will become property of the estate and used to repay creditors. The Debtor is, at best, uncertain how long the litigation might take, and there is no guarantee that the Debtor will prevail.
C. Action Against Insurer
The Debtor also intends to file a state court action against its own insurance carrier. The action would seek coverage for: (1) the encroachment of the horizontal and vertical easements; and (2) the attorney's fees the Debtor incurred in defending the Nies action in the trial court. The Debtor has identified an attorney who is willing to pursue this action on a contingent fee, perhaps minimizing the administrative costs to the estate. If the Debtor prevails in the litigation it once again hopes to increase the dividend that the estate will pay unsecured creditors. At a minimum, $146,313.60 or the amount the Debtor owes on the attorneys fees incurred to defend against the Nies lawsuit could be recovered from the insurer. Again, the Court is left to wonder about the duration of the litigation and whether the Debtor will ultimately succeed.
D. Action to Avoid Nies Judgment Lien
Subsequent to their state court judgment, the Nieses obtained a judgment lien against 3025 Ononta. Currently, the Nies lien is valued at $262,054.50 which represents the judgment obtained on the horizontal easement violation in the amount of $166,000 and the attorney's fees award for $92,000, plus accrued interest through the petition date. The Debtor hopes to file an adversary complaint to avoid the lien as a preferential transfer under § 547(b). If the Debtor succeeds with this action, the secured claims against 3025 Ononta would be reduced substantially, yielding a greater return for the general unsecured creditors of the estate, including the Nieses.
Debtor's Schedule F lists the Nieses' claim at $258,000. However, the Nieses filed a proof of claim for $262,054.50 which includes the post-judgment interest accrued through the date of the petition.
IV. Secured Debt
3025 Ononta is subject to multiple encumbrances. The Hamilton County Treasurer has filed a $21,517.49 claim for real estate taxes. The mortgagee, Stock Building Supply, Inc., has filed a claim for "$775,000.00 plus interest." The Debtor admits that it has not made any postpetition payments toward the property taxes or the mortgage. Simply put, it is fair to say that the Debtor has no intentions of making any payments on these obligations until all of the litigation terminates and the estate is liquidated under a chapter 11 plan it hopes to have confirmed.
There is also a mechanic's lien on the property. The lienholder filed a claim in the amount of $9,479.88.
Lastly, as noted, the Nieses currently hold a judgment lien for $262,054.50. Again, the Debtor hopes to avoid the judgment lien as a preferential transfer. Given the nature of this claim and that it would be tried in the bankruptcy forum, the Court has fewer concerns over delay or the probabilities of success than with the state court litigation previously discussed.
V. Value of 3025 Ononta
The vast majority of the evidentiary hearing on the Motion was devoted to valuing 3025 Ononta, both with and without the removed decks.
The Nies' appraiser, David Wuest, testified that the property is currently worth $630,000 without the decks, but could be sold for $690,000 if the decks were reinstalled.
The Debtor's appraiser, John McNally, testified that the property is currently worth $1,100,000. The Debtor also offered the expert testimony of a real estate agent, Denise Guiducci, who specializes in the sale of Ohio River view properties. Ms. Guiducci testified that the property is currently worth $1,115,000 without the decks and $1,245,000 if the decks are rebuilt.
Mr. McNally did not provide values with and without the decks. His report references "3 composite decks" but his photographs clearly show that the two decks deemed to have violated the easement had already been removed.
For tax purposes, the Hamilton County Auditor has valued the property at $889,920.
ISSUE
The question presented for consideration concerns whether "cause" exists, under § 1112(b)(1), which may require the Court, in the exercise of its sound discretion, to convert the case to one under chapter 7 or to dismiss it altogether.
ANALYSIS
Section 1112(b)(4)(A) defines "cause" to include "substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation."
This Court finds In re Original IFPC Shareholders, Inc., 317 B.R. 738 (Bankr. N.D. Ill. 2004) instructive on this point. Similar to here, the debtor in that case had completely ceased its business operations before filing for chapter 11 relief. It possessed only two assets, a $17,000 bank account and a cause of action for trade-secret-misappropriation. The debtor had already litigated the misappropriation claims in state trial court and lost. The debtor filed a chapter 11 petition and liquidating plan pending the appeal of the state court judgment and, if it ultimately prevailed on its cause of action, sought to use the proceeds of the suit to pay creditors of the estate an enhanced dividend.
In her well-reasoned decision, Judge Cox concluded that cause for dismissal or conversion existed due to "continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation." In reaching this conclusion, the court held that the first portion of the statute, loss or diminution, was satisfied because the debtor had no income to pay even administrative expenses. Judge Cox went on to hold that the second portion of the statute, absence of reasonable likelihood of rehabilitation, was satisfied where the debtor's only strategy to generate additional funds was through speculative litigation.
Prior to B.A.P.C.P.A., this example of "cause" was set forth in § 1112(b)(1). Under B.A.P.C.P.A., it is now set forth in § 1112(b)(4)(A). The only meaningful difference between the two is that B.A.P.C.P.A. added the words "substantial or" at the beginning of the subsection. Therefore, B.A.P.C.P.A. is broader, including continuing or substantial loss etc.
The facts of the case at bar resemble Original IFPC Shareholders, with the exception that here, no plan has been filed. Although the basic utilities for 3025 Ononta and the quarterly U.S. Trustee fees are being paid by the Debtor's sole member, Robert Fritzsch, no one is paying the postpetition installments on the $775,000 mortgage or the administrative expenses accruing; in particular, the attorney's fees for the estate, the property taxes and late payment penalties presumably being assessed. Nor has the Debtor suggested in statements to the Court that any of these payments would be made while it pursues the various lawsuits needed to fund the proposed chapter 11. Even if a chapter 11 plan had been proposed, it is likely to meet with stiff resistence from the Nieses. Undoubtedly, more administrative costs for payment of Debtor's attorney's fees will be incurred in an attempt to negotiate a consensual plan or to force a cram down over the anticipated objection to confirmation by the Nieses, very plausibly on good faith or feasibility grounds. See § 1129(a)(3) and (11).
As earlier noted, the Hamilton County, Ohio, Treasurer has already filed a secured claim for $21,517.49 in this case related to a pre-petition tax lien imposed against 3025 Ononta. 11 U.S.C. § 506(a) governs the amount that this secured tax claim will eventually be paid. In addition to payment of the tax claim secured by the property, the Debtor has an ongoing obligation to pay administrative expenses including,"any tax... incurred by the estate . . . including property taxes" and any "penalty." See 11 U.S.C. § 503(b)(1)(B) and (C).
Similar to Original IFPC Shareholders, also, the Debtor's sole proposal for rehabilitation is premised entirely upon the outcome of certain speculative litigation, including the appeal of a lawsuit where a judge has already ruled against the Debtor. At the very least, the Debtor faces an uphill battle that will be expensive, time consuming, and which may ultimately be unsuccessful. This is not to say that the Debtor's interpretation of the vertical aspect of the view easement is incorrect, nor that the Debtor cannot prevail in any of the litigation it intends to pursue; it is simply to say that creditors should not be made to bear the risk of any continuing losses to the estate without a greater probability for a successful rehabilitation than that which has been suggested.
It is questionable whether "rehabilitation" can even occur in a liquidating chapter 11. See Loop Corp. v. United States Trustee, 379 F.3d 511, 516 (8th Cir. 2004) (liquidating debtor has no likelihood of rehabilitation).
Finally, and importantly, since the entry of the order of relief in this case, the Debtor's failure to conduct any business activities has caused it to generate negative cash flow resulting in a net decrease in the value of its assets. The assets of the estate are losing value as the administrative expenses and the mortgage debt continue to accrue. Moreover, if the litigation, the only asset of the estate that the Debtor is counting on for payment of a proposed enhanced dividend to unsecured creditors in a chapter 11 plan, ultimately proves unsuccessful, unsecured creditors will likely receive less then they will now, and the secured creditors, the mortgagee and other lien holders, will see the value of their claims further erode.
Under these circumstances, the Court concludes that "cause" exists pursuant to § 1112(b)(4)(A) for the case to be dismissed or converted to chapter 7 because there is an absence of any reasonable likelihood of rehabilitation and there is very likely to be a substantial or continuing loss or diminution of the estate injurious to creditors.
II. Choice between Conversion and Dismissal
Having resolved that"cause" under § 1112(b)(4)(A) has been demonstrated by the movant, the Court must now decide whether it would be in the best interest of creditors and of the estate for the case to be converted to chapter 7 or dismissed. The movant seeks to have the case dismissed on the grounds that it was filed in bad faith, among other rationales. The movant is correct in noting that a bad faith filing of a chapter 11 petition constitutes "cause" for dismissal in our circuit. See In re Trident Assocs. Ltd. Partnership, 52 F.3d 127, 130 (6th Cir. 1995).
However, the decision on whether a chapter 11 case should be dismissed rests within the sound discretion of the bankruptcy judge based on the evidence presented. In re Citi-Toledo Partners, 170 B.R. 602 (Bankr. N.D. Ohio 1994). "Where the estate is not generating revenue but value exists to be maximized for creditor's benefit, and where the creditor body will have more enhanced protection in the federal bankruptcy forum than in noncollective state-court proceedings, conversion to Chapter 7 rather than dismissal may be appropriate." Original IFPC Shareholders, 317 B.R. at 753. A bankruptcy court need not give exhaustive reasons for its decision to convert a case to chapter 7; it need only explain why conversion is preferable to chapter 11. See Matter of Woodbrook Assocs., 19 F.3d 312, 317 (7th Cir. 1994); Citi-Toledo Partners, 170 B.R. at 609.
For many of the reasons previously discussed the Court is persuaded that, at this juncture, conversion rather than dismissal is in the best interests of the creditors and the estate. In reaching this conclusion, the Court also relied upon the following factors: 1) It is undisputed that the Debtor has abandoned any attempt to reorganize and its construction business has completely ceased operations; 2) The record also shows that the Debtor is suffering from a negative cash flow which is likely to persist for an indefinite period; 3) The administrative costs of the estate continue to accrue at a rapid pace from month to month and that trend is likely to continue for an extended period; 4) It is uncertain, at best, whether the Debtor will be able to formulate a chapter 11 plan in the face of the likely strenuous opposition it will confront from the Nieses, and any attempt to cram down a plan may prove very time consuming and expensive, with no guaranteed success; 5) The bankruptcy forum offers a chapter 7 trustee the ability to pursue a preference action against the Nieses that may increase the dividend for unsecured creditors over the non-collective statecourt proceedings; 6) The appointment of a chapter 7 trustee will also eliminate the expenses associated with an attempt to negotiate and confirm a plan; and 7) If causes of action are important assets of the estate, the appointment of a chapter 7 trustee is preferable because a trustee will be better equipped to expeditiously pursue the bankruptcy and non-bankruptcy causes of action and to collect, liquidate and distribute estate property in a manner consistent with the best interest of the creditors over the more expensive and time consuming chapter 11 process.
11 U.S.C. § 547 facilitates the prime bankruptcy policy of equality of distribution among creditors of the debtor. A preference cannot be recovered outside of bankruptcy. See Nostalgia Network, Inc. v. Leekwood, 315 F.3d 717, 719 (7th Cir. 2002).
What makes this case difficult is that the Debtor has a very strong and enviable desire to repay trade creditors with whom the Debtor's principal has probably done business with for many years. Perhaps, also, he might want to do business with these same companies and individuals in the future. It is apparent to the Court that the Debtor sincerely and honestly believes that a chapter 11 plan and confirmation process is the best way this can be accomplished. If everything goes according to script and the Debtor in short order is successful in each piece of litigation enumerated, the unsecured creditors of the estate might possibly receive a significant dividend in a chapter 11.
The problem with this approach lies in the fact that hardly anything is predictable when it comes to handicapping the outcome of lawsuits and the multiple appeals that can ensue. At bottom, litigation of any sort is an expensive and time-consuming undertaking fraught with unpredictability and uncertainties. It is not surprising, therefore, that bankruptcy courts, when faced with this question, have consistently held that attempts at solving financial problems through litigation, in the context of a chapter 11 filing, is too speculative an adventure and more often than not warrants conversion of the case. See In re Loop Corp., 379 F.3d 511 (8th Cir. 2004)("Because such causes of action could be pursued by a trustee in chapter 7, no advantage would be gained by remaining in Chapter 11; instead, time and resources would be wasted during a confirmation process that may never even be successful.") (citations omitted); Quarles v. U.S. Trustee, 194 B.R. 94, 97 (W.D.Va. 1996)(conversion was appropriate where the debtor's only hope to improve his financial problems through litigation was "pure speculation").
The purpose of § 1112(b) is to cut short the chapter 11 plan and confirmation process where it would be pointless. See Woodbrook Assocs, 19 F.3d at 317. Given the litigious history between the Debtor, its principal and the Nieses, undertaking a chapter 11 plan and confirmation process will be arduous and prohibitively expensive. Moreover, the Debtor lacks any ongoing operations or assets to pay even post-petition expenses. Thus, a chapter 11 plan and confirmation attempt is not likely to yield a better benefit to the estate or creditors than if the case was converted. Citi-Toledo Partners, 170 B.R. at 609 ("[t]he fact that creditors will likely enjoy greater rights in bankruptcy court than they would enjoy in state court militates in favor of conversion").
A chapter 7 trustee is needed to preserve the preference action that would be lost were the case dismissed, and to make an accurate assessment of the value to the estate, if any, of the pending and contemplated state court litigation. Finally, a chapter 7 trustee will also be able to determine the best way to liquidate the property at 3025 Ononta (and the 2002 van) in a manner that maximizes the return for creditors, thereby leading to the expeditious closing of the estate. Under the circumstances, conversion of this case is in the best interest of the creditors and the estate.
CONCLUSION
Based on the foregoing reasons, the Motion to dismiss will be DENIED and the case will be CONVERTED to chapter 7.
IT IS SO ORDERED.