Court: United States Bankruptcy Court, E.D. Michigan; October 13, 2017; Us Bankruptcy; United States Bankruptcy Court
The Chapter 11 case involves two opposing motions: the Debtor's "Turnover Motion," seeking an order to compel a state-court appointed receiver to return all property to the Debtor under 11 U.S.C. § 543(b), and CAN IV Packard Square LLC's "Cross-Motion," which requests to excuse the receiver from turnover requirements and suspend the bankruptcy case under 11 U.S.C. § 543(d)(1) and § 305(a)(1). Each party opposes the other's motion, and various interested parties have expressed support for either side. The Court held hearings on both motions on September 13, 2017, and on the Debtor's post-petition financing motion on September 19-20, 2017, which was subsequently denied. The Court concludes by denying the Turnover Motion, granting the Cross-Motion, and dismissing the bankruptcy case. Jurisdiction is established under 28 U.S.C. §§ 1334(b) and 157, deeming this a core proceeding as it involves statutory provisions of title 11. The Court references its prior opinion for detailed background information relevant to the motions.
In October 2014, the Debtor secured a construction loan from Canyon for a maximum principal amount of $53,783,184 to develop a mixed-use project in Ann Arbor, Michigan, comprising 249 residential units, retail space, and extensive parking. The loan was secured by a mortgage on the project property, including all related rights and assets, along with an assignment of leases and rents to Canyon.
On October 21, 2016, Canyon initiated a lawsuit against the Debtor in Washtenaw County Circuit Court, seeking the appointment of a receiver for the property and foreclosure of its mortgage. Canyon alleged that the Debtor failed to meet its construction obligations and maintain the property, citing multiple material defaults, including missing critical construction deadlines. Specifically, the Debtor was accused of not achieving substantial completion by the agreed date of October 26, 2016, and failing to enclose the building by a revised deadline of August 26, 2017. Canyon highlighted that the property remained exposed to the elements, increasing the risk of damage as winter approached. Additionally, Canyon noted that subcontractors Gaylor Electric and Jermor Plumbing had filed construction liens against the property due to non-payment, with more liens expected following the Debtor's termination of the general contractor, Quandel Construction Group.
Canyon notified the Court of the Debtor's defaults on a promissory note, resulting in its acceleration and full due status. Canyon claimed the Court could appoint a receiver based on the parties’ contract and the Construction Lien Act due to the Project's incomplete status, the Debtor's default, and risks of property damage. The Debtor acknowledged "technical defaults" related to missed milestones but sought a 150-day extension citing a force majeure clause, arguing that the case's equities warranted denying Canyon's receiver request. Ultimately, the state court rejected the Debtor's arguments and appointed McKinley, Inc. as receiver for the Project, effective immediately.
The Receivership Order, issued on November 1, 2016, found that the Debtor had defaulted on its loan obligations and failed to pay necessary expenses, constituting waste and jeopardizing Canyon's security interest. The court determined that the conditions for appointing a receiver under MCL 600.2927 and the Loan Documents were met, including the Project being incomplete and the mortgage defaulted. While the Debtor estimated the Project was 65% complete, Canyon presented evidence suggesting it was only 50% complete and required rework. The Receivership Order granted the Receiver extensive authority over the property to protect all interested parties, including the power to take possession, prevent waste, and complete construction.
The Receivership Order permitted the Receiver to enter into a loan agreement with Canyon for funding up to $19.7 million to winterize, safeguard, and complete construction of the Receivership Property, subject to court approval and secured by a "super priority" lien. The Receiver and Canyon sought state court approval for the loan documents, which was granted after a hearing on November 17, 2016, despite objections from the Debtor. A loan agreement was executed on November 22, 2016.
During the subsequent 10 months before the Debtor filed for bankruptcy, significant activity occurred regarding the Project, including ongoing litigation between the Debtor and construction lien holders, and between the Receiver and Canyon. The Debtor appealed the Receivership appointment and sought to appoint its preferred contractor, C.E. Gleeson Constructors, instead of the Receiver's chosen contractor, O’Brien Construction Company, which the state court denied. The Debtor's motion for reconsideration of the Receivership order was also denied.
The state court litigation involved various objections and motions by creditors with construction liens, including Gaylor Electric, Inc. and Quandel Construction Group, which sought amendments to the Receivership Order and claimed breaches of fiduciary duty against the Receiver. These motions were denied on June 22, 2017. Most recently, on August 31, 2017, the Receiver and Canyon filed a joint motion to increase the borrowing limit for the Receivership Loan from $19.7 million to $37.5 million to facilitate project completion.
The motion asserted that the Receiver has effectively fulfilled his responsibilities since the Receivership Order, incurring $8.9 million in costs while indicating that the remaining $19.7 million Receivership Loan is inadequate for project completion. It was noted that the initial loan was based on an unrealistic budget from the Debtor, and that project costs had risen due to the Debtor's poor workmanship and other issues. A hearing for the joint motion was scheduled for September 7, 2017, but was canceled as the Debtor filed for bankruptcy on September 5, 2017, more than ten months after the Receiver's appointment. In the bankruptcy proceedings, various parties expressed their positions on the Turnover Motion and Canyon’s Cross-Motion, with several creditors supporting the Debtor due to construction liens for work done prior to the Receiver's appointment. Conversely, Canyon’s position was backed by the Receiver and associated contractors. During the hearing on September 13, 2017, oral arguments were presented by the Debtor, Canyon, and most supporting parties, while the United States Trustee appeared without submitting a written response, suggesting that if the Receiver is excused from turnover obligations, the case should either be dismissed or converted to Chapter 7 instead of being suspended. Canyon’s Cross-Motion sought suspension, but indicated a preference for dismissal if turnover is excused.
On September 14, 2017, the Court mandated Canyon to submit supplemental exhibits related to the Motions by September 18, 2017. Required documents included: (a) the current docket sheet for the state court receivership case (CAN IV Packard Square LLC v. Packard Square, LLC, et al., Case No. 16-000990 CB), (b) transcripts of all hearings in the state court case except for the October 27, 2016 hearing, and (c) motions filed by Gaylor Electric, Inc. and Quandel Construction Group, Inc. in May or June 2016 against the Receiver for breach of fiduciary duties.
The Order indicated that the Court would determine the necessity of an evidentiary hearing on the Motions after the required documents were filed; if no hearing was deemed necessary, a written opinion or order would be issued instead. Canyon complied with the Court's order.
In the Turnover Motion, the Debtor requested the Court to compel Receiver McKinley to turn over and account for all Debtor's property in his possession, pursuant to sections 543(b)(1) and (b)(2) of the Bankruptcy Code. Conversely, Canyon's Cross-Motion sought to excuse McKinley from these obligations under section 543(d)(1) and to suspend the bankruptcy case under sections 305(a)(1) and 105(a), allowing McKinley to operate under state court supervision to prevent unnecessary expenses and confusion regarding jurisdiction.
Section 543 of the Bankruptcy Code prohibits a custodian from disbursing or administering a debtor's property after the commencement of a bankruptcy case, except actions necessary to preserve the property. It also mandates that a custodian deliver any debtor's property in their possession to the trustee and file an accounting of such property.
The court, following notice and a hearing, must: (1) safeguard all entities to which a custodian has obligations concerning property or its proceeds; (2) ensure reasonable compensation for the custodian's services and incurred costs; and (3) surcharge the custodian for any improper or excessive disbursements, except for those made in accordance with the law or pre-approved by a competent court. The bankruptcy court may excuse compliance with certain subsections if it serves the interests of creditors or equity security holders better, particularly if the custodian is an assignee for the benefit of creditors appointed over 120 days before the petition filing, unless necessary to prevent fraud or injustice. A custodian, upon learning of a bankruptcy case, is obligated to turn over the debtor's property to a trustee or, in a Chapter 11 case without an appointed trustee, to a debtor-in-possession. A state court receiver qualifies as a "custodian" under the relevant law. The bankruptcy court has discretion to exempt a state court receiver from mandatory turnover obligations if it benefits the creditors or equity security holders. The burden of proof lies with the party seeking relief to demonstrate that allowing the custodian to retain control serves the best interests of creditors and equity holders if the debtor is solvent.
Courts evaluate various factors to determine if the burden of proof has been met in reorganization cases, including: (1) the likelihood of successful reorganization; (2) availability of funds for reorganization; (3) evidence of debtor mismanagement; (4) potential harm to creditors from turnover; (5) whether the debtor will use the property to benefit creditors; (6) the presence of avoidance issues related to property held by a receiver, who lacks avoidance powers; and (7) the impact of the bankruptcy automatic stay on state court receivership actions. The primary focus is on the interests of all creditors and, if the debtor is solvent, the interests of equity security holders. Generally, reorganization policy favors turning over business assets to the debtor in Chapter 11 cases. However, when a state court-appointed receiver is involved, courts consider the duration and actions of the receiver and their effect on the interests of creditors. If it is demonstrated that creditors would be better served by the receiver retaining control, bankruptcy courts may deny turnover motions. Section 305(a)(1) of the Bankruptcy Code provides that a court may dismiss or suspend proceedings if it determines that doing so would better serve the interests of creditors and the debtor. This decision is discretionary and made on a case-by-case basis, allowing bankruptcy courts to abstain even when jurisdiction exists.
The pendency of state law liquidation proceedings is significant in determining whether to abstain from bankruptcy under section 305(a)(1). Courts may choose abstention when a bankruptcy case would duplicate efforts and waste resources due to prolonged receivership. Section 305 allows a bankruptcy court to dismiss or suspend proceedings when state court actions serve the interests of the parties involved. Factors to consider for abstention include: the efficiency of administration; availability of alternative forums; necessity of federal proceedings for equitable solutions; alternatives for asset distribution; potential for out-of-court arrangements; the extent of progress in state proceedings; and the purpose of seeking bankruptcy jurisdiction. Dismissal under section 305(a)(1) is warranted only when it benefits both creditors and the debtor. Courts assess the duration of state receivership and the actions taken by the receiver. Examples include cases where receiverships had been active for several months prior to bankruptcy filings, leading to dismissals to avoid duplication of efforts and unnecessary costs.
An evidentiary hearing on the Turnover Motion and Canyon’s Cross-Motion is deemed unnecessary by the Court. It finds that excusing Receiver McKinley from turnover and accounting obligations under 11 U.S.C. §§ 543(b)(1) and (b)(2) and dismissing the bankruptcy case under 11 U.S.C. § 305(a)(1) better serves the interests of creditors and equity security holders. The Court assumes the Debtor is solvent for the analysis, noting that both creditors and equity holders have aligned interests in excusing turnover to facilitate the completion of a construction project in Ann Arbor. The critical factor influencing this decision is the denial of the Debtor’s DIP Financing Motion, which has left the Debtor without funds to advance the project or its bankruptcy case. The Debtor claims it needs approximately $11.9 million to complete the project, but this figure is contested by Canyon. The Court concluded that the Debtor's proposed financing terms, involving a priming lien that inadequately protects existing lien holders, render it impossible for the Debtor to secure financing, thus impairing its ability to progress on the project.
The existing state court receivership is deemed the only feasible option to complete and stabilize the Project. The Receiver, if allowed to continue its efforts initiated before the Debtor filed for bankruptcy, is expected to secure necessary financing through an amended Receivership loan from Canyon. Consequently, the Court is urged to deny the Debtor’s Turnover Motion and grant Canyon’s Cross-Motion, as this decision is necessary to prevent delays and inefficiencies that would arise by allowing the Debtor to take control of the Project again.
The Debtor has previously changed contractors twice: first by dismissing general contractor Quandel and then by appointing the Receiver, who selected O’Brien Construction. The Debtor's current aim is to reinstate Gleeson as the general contractor, which would represent another disruptive change after O’Brien has been engaged for over ten months.
While the Debtor, Quandel, and Gaylor have raised numerous complaints regarding the Receiver’s actions and the Receivership Loan in both the state court and this Court, these complaints are contested by Canyon and the Receiver, with some already addressed by the state court. The state court remains the proper venue for grievances, and parties dissatisfied with its rulings can appeal to the Michigan Court of Appeals. The Court expresses confidence in the state court's capability to adjudicate these matters fairly. Additionally, under Michigan law, the Receiver has a fiduciary duty to all lien holders, not just Canyon, ensuring equitable treatment.
A receiver appointed under this section acts as a fiduciary for all parties with interests in the real property and must adhere to extensive supervisory authority granted by the Receivership Order and Michigan law. The state court is designated as the proper venue for resolving disputes among the parties. The court concludes that it is in the best interest of creditors and equity security holders to allow the Receiver to maintain control of the Debtor’s property, and that dismissing the bankruptcy case serves the interests of both creditors and the debtor. The court abstains from the bankruptcy proceedings in favor of the state court receivership, determining that merely suspending the bankruptcy case would be ineffective. Therefore, the court opts for dismissal to eliminate confusion regarding the Receiver's authority. Additionally, a two-year bar on any new bankruptcy filings by or against the Debtor is imposed to support the completion of the state court receivership. The court will deny the Debtor's Turnover Motion, grant Canyon’s Cross-Motion, and dismiss the bankruptcy case, barring new filings for two years. Written responses from various parties regarding the motions are documented, and the court has also considered input from an unsecured creditor who supports the Debtor's position.
Exhibit 3 through Exhibit 9 detail a series of state court hearings and motions related to the receivership and various objections filed by the defendant and other parties. Key points include:
- **December 15, 2016 Hearing**: Focused on the Defendant’s Motion to Direct the Receiver.
- **January 19, 2017 Hearing**: Addressed the Defendant’s Objection to the Receiver’s Draw Request.
- **March 16, 2017 Hearing**: Included the Defendant's objections to Receiver Reports and the Receiver's Motion to Approve a Supplemental Budget.
- **April 13, 2017 Hearing**: Centered on Canyon’s Motion for a Protective Order.
- **June 22, 2017 Hearing**: Covered multiple motions from Gaylord, including a request to file a third-party complaint against the Receiver, motion to amend the receivership order, and objections to Receiver Reports. Quandel also filed objections and a motion for relief from the receivership order.
- **August 17, 2017 Hearing**: Discussed D.V. Excavation’s Motion for Summary Disposition regarding the Defendant's cross-claim.
Additional documents filed by Canyon at Docket 109 include various motions and objections from Gaylor Electric Inc., Quandel Construction Group Inc., Amthor Steel, and Zeeland Lumber, all related to the receivership proceedings. Notably, orders denying motions from Gaylor Electric and Quandel regarding amendments to the receivership order and objections to Receiver Reports were also issued.
The excerpt also references section 543(d)(1), which allows for a modified abstention provision similar to section 305 of the Code, citing relevant case law for context.
