Mortgagee Relief: “Cause” Is In the Eye of the Beholder – Round 2

In re GEL, LLC, 495 B.R. 240 (Bankr. E.D. N.Y. 2012) –

A mortgagee moved to dismiss two Chapter 11 bankruptcies that were filed by its mortgagors to prevent a scheduled foreclosure sale.  It also sought relief relating to the automatic stay arising from future bankruptcy filings.  The bankruptcy court agreed that there was “cause” to dismiss the cases, and further that the mortgagee was entitled to an order that would prevent application of the automatic stay to the mortgaged property in connection with bankruptcies filed within 2 years.

The mortgagee (Archer) made a $2.6 million loan to the debtors (GEL and GRL) secured by mortgages on real estate (including a building leased for use as a medical office by the father of the principal of the debtors who was subject to an eviction proceeding for failure to pay rent).  The loan was guaranteed by an affiliate (Eagle), which was also secured by real estate.

After the loan matured and was not paid, the mortgagee commenced a state foreclosure action against GEL and GRL.  Almost 3 years later, it obtained a judgment of foreclosure and a sale was scheduled.

GEL, GRL and Eagle each filed bankruptcy on the day of the foreclosure sale.  All 3 petitions were eventually dismissed.  About a month later, GEL and GRL filed new bankruptcy petitions in a different district.  The second bankruptcy court determined that venue was improper, and transferred the cases back to the original bankruptcy court, where the mortgagee asked that the cases be dismissed once again.

As an initial step, the bankruptcy court reviewed the grounds for granting relief under Section 1112(b) of the Bankruptcy Code, noting that it had “wide discretion” to determine whether cause for relief exists and whether to dismiss or convert the case.  Since the debtors allowed property insurance to lapse and failed to file any of the monthly reports required by the U.S. Trustee, the court found cause to dismiss the case under Sections 1112(b)(4)(C), 1112(b)(4)(F) and 1112(b)(4)(H).

However, the court then went on to determine that the bankruptcy petitions were not filed in good faith, which also constituted cause for relief.  It noted that the debtors did not have any employees or cash flow, and “[f]undamental to any bona fide corporate reorganization effort under Chapter 11 of the Bankruptcy Code is that the entity seeking relief have assets, liabilities, creditors, employees and business operations.”

It also noted that the mortgagee had an unsecured deficiency claim of over $1 million, and there were few other non-insider creditors.  (GRL owed $27,500 to one creditor, the debtors scheduled claims of the city’s water board and department of tax and finance in unknown amounts, and the IRS filed claims totaling ~ $20,000.)  In essence, this was a two-party dispute between the debtors and the mortgagee, and according to the court the debtors would not be able to confirm a plan of reorganization over the objection of the mortgagee.  Thus, “the filing of these chapter 11 cases ‘is the very essence of a bad faith filing – commenced in an effort to gain the upper hand in state court litigation, with a demonstrable absence of any possibility of confirming a chapter 11 plan.’”

Finally, the court addressed the mortgagee’s request to lift the automatic stay in future bankruptcy filings pursuant to Section 362(d)(4) based on the allegation that the filings were “part of a scheme to delay, hinder, or defraud creditors that involved … multiple bankruptcy filings affecting [its mortgaged collateral].”  Considering the successive bankruptcy filings in two districts, the failure to pursue a plan of reorganization, and the fact that the debtors defaulted and made no payments for more than 4 years, the court agreed to enter an order that for a period of two years a future bankruptcy filing would not operate as a stay of any action against the mortgaged properties.

As this case illustrates, a mortgagee should not count on being able to realize on its collateral in a short period of time.  Most of the delay (~ 3 years) was due to the slow pace of state foreclosure proceedings, but even with a very sympathetic bankruptcy judge, it took the mortgagee more than 10 months to extract itself from the bankruptcy process.  And portions of the opinion suggest that the bankruptcy court would be inclined to look with disfavor on most typical single asset real estate cases.  In a court that is more receptive to real estate cases, 10 months could easily turn into a longer period.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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