Filing on the Eve of Foreclosure: Sometimes It Works, and Sometimes It Doesn’t

In re LJBV Ltd., 544 B.R. 401 (Bankr. N.D. Ill 2016)

The debtor filed a Chapter 11 case immediately after a receiver was appointed in a state foreclosure proceeding. The mortgagee filed a motion to dismiss the bankruptcy case for cause.

In June 2015 the mortgagee filed a foreclosure case against the debtor and a co-obligor in state court. It also filed a motion seeking appointment of a receiver. The bankruptcy court noted that apparently the defendants then filed six successive motions for substitution of judge under a state statute that permits a party one substitution of judge without cause as a matter of right. The receiver motion was eventually granted in October 2015.

The debtor’s sole business was owning and operating a commercial building with 4 tenants. According to the schedules filed by the debtor – which the court noted were filed late without leave of the court – the property was subject to a secured claim of ~$1.3 million. The bankruptcy court also noted that it later came out that the property actually secured debt of ~$5.7 million. The schedules also showed only ~40,365 for real estate taxes and other unsecured debt of only ~$8,675.

The debtor complained about the impropriety of the state court receiver appointment, and improper conduct of the mortgagee representative in objecting to a sale of the property in a conversation with a prospective purchaser. With respect to the sale, the court commented that it was apparently supposed to close postpetition in December 2015 even though no motion to sell was filed in bankruptcy court until January 2016.

The mortgagee’s position was that “the Debtor’s preoccupation with what happened in state court means that this case was filed in bad faith.”

Under section 1112(b)(1) of the Bankruptcy Code, a court can convert a chapter 11 case to a chapter 7 case or dismiss the case, whichever is in the best interests of creditors in the estate, for “cause.” Section 1112 (b)(4) provides:

(4) For purposes of this subsection, the term “cause” includes—

(A) substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation;

(B) gross mismanagement of the estate;

(C) failure to maintain appropriate insurance that poses a risk to the estate or to the public;

(D) unauthorized use of cash collateral substantially harmful to 1 or more creditors;

(E) failure to comply with an order of the court;

(F) unexcused failure to satisfy timely any filing or reporting requirement established by this title or by any rule applicable to a case under this chapter;

(G) failure to attend the meeting of creditors convened under section 341(a) or an examination ordered under rule 2004 of the Federal Rules of Bankruptcy Procedure without good cause shown by the debtor;

(H) failure timely to provide information or attend meetings reasonably requested by the United States trustee (or the bankruptcy administrator, if any);

(I) failure timely to pay taxes owed after the date of the order for relief or to file tax returns due after the date of the order for relief;

(J) failure to file a disclosure statement, or to file or confirm a plan, within the time fixed by this title or by order of the court;

(K) failure to pay any fees or charges required under chapter 123 of title 28;

(L) revocation of an order of confirmation under section 1144;

(M) inability to effectuate substantial consummation of a confirmed plan;

(N) material default by the debtor with respect to a confirmed plan;

(O) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan; and

(P) failure of the debtor to pay any domestic support obligation that first becomes payable after the date of the filing of the petition.

Although not specifically included in this section, courts generally hold that a lack of good faith can also constitute cause.

In a prior opinion the bankruptcy court also identified the following as factors that it used to determine whether there was cause to dismiss:

(1) whether the debtor has few or no unsecured creditors;

(2) whether there has been previous bankruptcy filings by the debtor;

(3) whether the pre-petition conduct of the debtor has been improper;

(4) whether the petition effectively allows the debtor to evade court orders;

(5) whether there are few debts to non-moving creditors;

(6) whether the petition was filed on the eve of foreclosure;

(7) whether the foreclosed property is the sole or major asset of the debtor;

(8) whether the debtor has no ongoing business or employees;

(9) whether there is no possibility of reorganization;

(10) whether the debtor’s income is not sufficient to operate;

(11) whether there was no pressure from non-moving creditors;

(12) whether reorganization essentially involves the resolution of a two-party dispute;

(13) whether a corporate debtor was formed and received title to its major assets immediately before the petition and;

(14) whether the debtor has filed solely to create the automatic stay.

The court catalogued a number of factors that were present in this case. It also commented on the debtor’s preoccupation with some sort of conflict of interest involving the state court receiver, noting that this was an issue for state court not the bankruptcy court, and found that the debtor wanted to sell its property in the bankruptcy case so that it could control who obtained the property with less interference from the mortgagee. The court paid particular attention to the fact that an insider tenant was charged only $500 for space that was worth $8, 000-$10,000 and gave no explanation justifying the reduced rent.

The court’s general guiding principle was that bankruptcy is “designed to preserve enterprise value and to give deserving debtors a fresh start” – noting that neither purpose was evident in this case. It concluded that the debtor’s purpose was to forum shop and avoid the state court foreclosure proceeding, as opposed to benefiting creditors. Consequently, the court granted the motion to dismiss.

There are a variety of cases that suggest a laundry list of factors that can be considered in determining whether to convert or dismiss for cause. This approach, as illustrated by this case, suggests that the determination of “cause” is often a case of “I’ll know it when I see it.”

A debtor should keep in mind that there is no bright line test, and a court might take action to dismiss its case based on the court’s conviction that the debtor does not deserve to be in bankruptcy. On the other hand, an objecting party also needs to recognize that there is no bright line test, and it may not be able to obtain relief even though from its perspective the debtor is clearly abusing the bankruptcy process.

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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