You Gotta Have Faith, The Good Kind Of Course. Bankruptcy Court Dismissed Petition for Bad Faith Filing
March 14, 2014
Filing for bankruptcy is a great economic strategy when reserved for periods of limited cash flow and excessive debt, but its effect quickly diminishes when it becomes the designated go-to method to stave off troubling financial events. Unfortunately, for the debtor in In re Hartford & York LLC, it opted for the bankruptcy-as-the-first-resort method which resulted in a dismissal on grounds of bad faith.
Stabilis Fund II, a mortgagee’s successor-in-interest and the largest creditor in the case, moved the court to (i) void the debtor’s petition because it was not filed by an attorney, (ii) dismiss the case as a bad faith filing, (iii) grant the creditor relief from the automatic stay since the case’s inception to ratify the foreclosure sale, and (iv) bar the debtor from filing a bankruptcy petition for 120 days following the dismissal of this case. The request can seem quite demanding for a single creditor, but this creditor held 98% interest of the debtor’s secured claims and 97% of all claims. Hartford & York was a corporate single asset real estate debtor. In 2009, Hartford & York (the "Debtor") used its real property (which is also its principal asset) and an assignment of rents and leases to secure financing from Madison National Bank. In less than two years, Madison filed a state court action to foreclose on its interests in the property. The court appointed a receiver to possess and operate the property a month after the foreclosure filing.
The receiver managed to delay the inevitable but could not fully save the property. During its receivership, the Debtor failed to have a steady incline of net cash flow or even consistent net cash flow. The first couple of months yielded negative cash flow. And while the following year seemed to produce more positive results, the Debtor again suffered negative cash flow. By 2013, with the Madison National Bank having transferred its interest in the state court proceeding, Stabilis was granted the right to foreclose on the property to collect amounts due under the mortgage note. Stabilis set the foreclosure for May 23, 2013, but less than an hour before the sale, the debtor filed for bankruptcy with the assistance of counsel. The creditor moved for a dismissal, and by July 2013, the Debtor, trustee and Stabilis agreed to a dismissal.
Of course, like any other creditor, Stabilis re-scheduled the foreclosure sale for a date in September. But once again, the debtor filed for bankruptcy only moments before the sale but without counsel. At this point, it seems that the record is broken because the same song was being played.
Stabilis eventually obtained some sort of relief with the dismissal of the Debtor’s bankruptcy case; however, the relief fell short on some fronts.
Petition Void Ab Initio
Stabilis moved to declare the petition void ab initio because the Debtor filed the case without the assistance of counsel. The law requires a corporation to appear in court by counsel. While a corporation’s court appearance must be through counsel, its initial filing of the case does not have to be. Additionally, the Debtor obtained counsel a few weeks after the filing of the bankruptcy petition. For that reason, the court did not void the filing.
Relief from Automatic Stay
As an alternative to void the petition ab initio, Stabilis sought relief from the automatic stay nunc pro tunc in order to ratify the foreclosure sale that occurred in September 2013. Courts consistently recognize the importance of the automatic stay by voiding proceedings or actions described in Section 362(d)(1) of the bankruptcy code. Although some courts interpreted Section 362(d) to empower courts to lift the automatic stay from the date of the sale in certain circumstances, the cases in which subsequent actions are voided remain the prevailing authorities. Because the Debtor filed for bankruptcy protection moments before the sale, Stabilis’ foreclosure sale remained null and void, thereby forcing it to go through the same song and dance of setting a new foreclosure sale.
Bar Future Filing within 120 Days
The court granted Stabilis’ request to bar the Debtor from re-filing within 120 days, somewhat. To ensure that the Debtor would not be denied the benefit of the fresh start should the need arise in the immediate following months, the court did not bar the Debtor from filing but rather denied it the benefit of the automatic stay unless the presiding court determined after hearing and notice that the filing was made in good faith.
The Dismissal on Bad Faith Grounds
Stabilis’ relief came in the form of a case dismissal (together with the denial of the automatic stay, discussed supra). The bankruptcy code permits an interested party to request a case dismissal for cause and bad faith can be the cause. Judge Elizabeth Stong relied on the eight factors established in C-TC 9th Avenue Partnership v. Norton Co. (In re C-TC 9th Ave P-ship). Applying those factors here, the Debtor satisfied each prong of the C-TC test, thereby warranting a dismissal. Each of the following factors resulted in the dismissal of the Debtor’s case:
The Debtor’s only asset was the property that it used as security for the consolidated mortgage in 2009.
The debtor had only four other creditors – three secured and one unsecured. The three secured creditors were entities of the City of New York and the unsecured creditor was the Internal Revenue Service. Focusing on the one unsecured claim, it only represented less than 1% of all claims.
The only asset of the Debtor is the subject of a state foreclosure proceeding caused by arrearages or default on the consolidated mortgage.
The Debtor’s financial condition was essentially a dispute between it and Stabilis, which could have been resolved through the state foreclosure action.
The Debtor’s filings of each of bankruptcy petitions only moments before each foreclosure sale evidenced its intent to frustrate or delay Stabilis’ efforts to enforce its rights.
In the years preceding its bankruptcy filings, the Debtor had negative cash flow except for one of the years that it was in receivership. But that one good year was immediately followed by another year of negative cash flow.
The Debtor lacked the ability to pay its expenses including taxes as evidenced by operating statements as well as the monies due to the New York City Water Board and the IRS.
The Debtor’s only employee is a part-time superintendent who does not reside on the premises.
These factors coupled with the Debtor’s lack of progress towards reorganization since the inception of the case supported a finding of bad faith and gave Judge Stong reason to dismiss the case.
A few facts are of particular interest. After the court appointed a receiver to manage the property in 2010, the company was again in dire financial straits within only a few years’ time. Ideally, a receiver will maximize the company’s value during the tenure of receivership. Here, property’s rent intake increased by 18 times its value from the time the receiver took possession; however, the increase was not enough to avoid bankruptcy. The bank apparently realized the absence of value and chose to dispose of its interest in the property. Although it is customary for banks to relinquish their interests in mortgages through the securitization process, it seems more like the bank was cutting its losses. It was four years after the creation of the mortgage and the securitization market declined tremendously (ahem, the mortgage crisis), which made the Debtor’s property ripe for the taking by a private equity firm (in walks Stabilis). When these facts are considered, bankruptcy becomes less of a plausible option. The property did not make money and the probability of a reorganization was nearly non-existent. At that point, bankruptcy was merely a tool to hold on to a bad asset, not a strategy or at least a good strategy.
Protecting bad assets waste time that could be invested into rebuilding. Rebuilding does not have to be a reorganization in lieu of liquidation, but it is the process of moving forward and starting anew. Inherent in the bad faith idea is the question are you going to rebuild. If rebuilding is not a consideration or even a possibility, then bankruptcy is not the resolution. You need good faith.