In re Fairfield Tic, LLC

Citation: 594 B.R. 852Docket: CASE NO. 18-73744-VJ

Court: United States Bankruptcy Court, E.D. Virginia; December 4, 2018; Us Bankruptcy; United States Bankruptcy Court

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U.S. Bank National Association, acting as Trustee for LB-UBS Commercial Mortgage Trust 2007-C7, has filed a motion to dismiss the bankruptcy case of Fairfield TIC, LLC, citing "cause" under Section 1112(b) of the Bankruptcy Code. Susan E. Collins, a court-appointed Receiver for the property's management, has joined this motion. The Noteholder additionally seeks relief from the automatic stay under 11 U.S.C. § 362(d). 

The Debtor, a Delaware LLC focused on real estate investment, holds a 66.2296% tenant-in-common interest in the Fairfield Shopping Center in Virginia Beach. The remaining interests are owned by three other entities that have not filed for bankruptcy. The TIC Agreement governing the property requires unanimous consent for decisions regarding management and sale. The TICs purchased the property for approximately $22.5 million in 2004, financing it through their investments and a $19 million loan from G.E. Capital. In 2007, the property was appraised at nearly $38 million, leading the TICs to refinance through a $30 million loan from Lehman Brothers, which has since been acquired by the Noteholder.

As of the trial on November 20, 2018, the property is valued at no more than $27 million, but the TICs owe about $30 million in principal and interest on the matured loan. An exit strategy involving the acquisition of the property by Wheeler Real Estate Investment Trust was disrupted when Jon Wheeler lost control of the REIT in 2017, resulting in the REIT's decision not to proceed with the acquisition. Attempts to negotiate a loan extension or find a buyer have not yielded a concrete exit strategy. Subsequently, on February 15, 2018, the Noteholder sought the appointment of a receiver for the property in Virginia Beach.

On March 15, 2018, Susan E. Collins was appointed as receiver, taking control of the Property. Subsequently, Nikki Providence Road, LLC initiated a lawsuit against the tenants-in-common (TICs) related to a 2015 agreement for selling part of the Property, which is currently stayed due to the Debtor's bankruptcy. A foreclosure sale was initially set for July 2018 but was canceled by the Noteholder after the TICs considered filing for Chapter 11 to protect their interests. The Noteholder later executed a Deed in Lieu of Foreclosure with GCK TIC, LLC, and scheduled another sale for October 29, 2018. The Debtor filed for Chapter 11 on October 23, 2018, without the other TICs joining the petition. The Noteholder and Receiver moved to dismiss the case under 11 U.S.C. § 1112(b), alleging the Debtor did not act in good faith. Alternatively, the Noteholder requested relief from the automatic stay under 11 U.S.C. § 362(d).

The Court has jurisdiction as per 28 U.S.C. § 1334 and relevant orders, determining the matter is a "core" bankruptcy proceeding. The dismissal request under 11 U.S.C. § 1112(b) emphasizes that the court must dismiss or convert the case for cause, with "bad faith" filings identified as valid grounds for dismissal. The Fourth Circuit’s interpretation requires that a debtor demonstrate good faith in filing for Chapter 11, and a finding of bad faith must consider both objective futility of reorganization and subjective intent to misuse the process. While there are no specific factors mandated, courts should evaluate the "totality of circumstances," considering behaviors indicative of bad faith or futility.

Several indicators suggest a lack of good faith in bankruptcy cases, as highlighted in the Fifth Circuit's decision in *In re Little Creek Development Co.* Key factors include: the debtor possessing only one asset (often real property) encumbered by secured creditors' liens; minimal or no cash flow; no viable income sources to support a reorganization plan; and typically a few unsecured creditors with small claims. Properties are often posted for foreclosure due to debt arrears, with unsuccessful defenses against foreclosure in state court.

In *In re Castleton Associates, Limited Partnership*, the debtor's sole asset was an apartment complex managed by an independent contractor. The court observed that the debtor effectively had no business operations, relying entirely on the management company for property maintenance and management. Ultimately, the court dismissed the case, concluding it did not align with bankruptcy's objectives but aimed to mitigate poor business decisions.

Similar analyses have been applied in other cases, such as *In re Kinard*, where the court identified objective futility due to the debtor's lack of significant assets and income, and subjective bad faith stemming from a two-party dispute, limited unsecured creditors, and the timing of the bankruptcy filing suggesting an intention to delay creditor collections.

In the current case, applying the *Little Creek* and *Kinard* factors confirms objective futility. The debtor is a single-asset entity with a 66% interest in a fully encumbered property, limited revenue access, and no viable reorganization plan without support from co-owners, who have opted out of bankruptcy. The debtor holds no equity as the Noteholder's lien on the property exceeds its value, indicating that even full ownership would not alleviate the encumbrance.

The Debtor possesses only a 66% interest in the property and is jointly and severally liable for the associated obligation, resulting in no equity from its sole asset. The Noteholder contends that the Debtor lacks income or cash flow and functions as a passive investor, a characterization the Court supports. Under Section 1031 of the Internal Revenue Code, the Debtor can receive only its 66% share of net profits after expenses, but has assigned its right to collect net proceeds from rents to the Noteholder in case of default. Having defaulted on the loan when it matured in October 2017, the Debtor currently cannot access any proceeds or cash flow from the property, which is also under the control of a Receiver, further restricting access to funds.

Testimony indicates that the Debtor's involvement in management is limited to minor actions like signing leases, lacking the active management role typical of property management companies. Despite the TIC Agreement allowing for a management company and some participation in decisions, actual management is now conducted by the Receiver, not the TICs. The Debtor’s assertion of needing access to all cash flow for reorganization is undermined by the lack of other income sources. Thus, the Debtor's capacity to influence the property's management and generate income is severely constrained.

The Noteholder contends that any reorganization plan proposed by the Debtor could infringe on the rights of non-Debtor TIC interest holders, who are not parties to the bankruptcy case. The TIC Agreement mandates that unanimous approval from all Tenants is required for significant decisions regarding property management and sales. The Debtor's plan, which includes selling property to Nikki Providence Road, would necessitate consent from all TICs, including non-Debtors. Since these non-Debtor TICs have neither appeared in this case nor filed for bankruptcy, any court-approved plan would unjustly alter their ownership rights.

The Debtor attempts to counter the Noteholder's claims by suggesting that the TIC agreement was previously violated by GCK and the Noteholder through a Deed in Lieu of Foreclosure, but fails to provide a legal rationale for how this breach permits the Debtor to remain in bankruptcy or compel action from other TICs. Although the Debtor refers to cases like In re Orchards Village Invs. LLC and In re Southfield Office Bldg. 14, LP to support its position, it is noted that the Southfield case did not confront a motion to dismiss under Section 1112(b), and thus does not provide strong precedent. The Orchards Village case involved a more active role by the debtor in property development, distinguishing it from the Debtor's situation, and the court's dismissal decision hinged on the lack of identified cause for dismissal, unlike the Fourth Circuit, which recognizes general bad faith as valid cause under Section 1112(b).

The Debtor references cases where automatic stay relief was granted, emphasizing that such decisions typically followed some level of debtor reorganization. The court finds the case of In re Geneva ANHX IV LLC particularly relevant, as it addressed substantive consolidation and its limitations. In Geneva, the court ruled that a debtor could not compel non-debtor TIC entities to merge their assets into the bankruptcy estate, deeming such use of substantive consolidation improper. The Debtor's proposed plan aims to bind non-debtor TICs to a restructured loan and a sale of property, which the court sees as an attempt to pool interests to benefit the Debtor's Chapter 11 case.

Additionally, the Debtor seeks to appoint a new management company, potentially undermining the TIC Agreement and allowing unilateral management changes. The Debtor proposes refinancing or sale options that would enable collective reorganization, claiming that some TICs are open to these alternatives. However, this situation parallels In re AMA Corp., where the court found objective futility due to the debtor's inability to secure financing or develop a feasible business plan after extensive time. The Noteholder points out a year elapsed between the Debtor's default and the bankruptcy filing, during which efforts to refinance or sell the Property were unsuccessful. The court aligns with AMA Corp.'s conclusion that the Debtor is unlikely to achieve a viable reorganization plan, rejecting the notion that a single-asset Chapter 11 case would yield different outcomes. The Debtor contends that its situation does not imply a blanket inability for TIC structures to reorganize, citing Mr. Wheeler's belief in the non-debtor TICs' potential support for a reorganization plan.

The Court rejects the Debtor's arguments regarding its bankruptcy filing. Testimony indicated that the four Tenants in Common (TICs) discussed bankruptcy following a foreclosure sale scheduled by the Noteholder in July 2018. The Debtor filed for bankruptcy in October 2018 without the support of the other TICs, one of whom had already entered a Deed in Lieu of Foreclosure Agreement with the Noteholder. The Court finds the lack of support from the non-Debtor TICs undermines the Debtor's claims of potential unanimous backing. The Debtor had sufficient opportunity to persuade the non-Debtor TICs to join its filing but chose to file individually, indicating a strategy that the Court does not endorse. 

Citing the Geneva case, the Court asserts that non-Debtor TIC owners retain their rights under state law despite the bankruptcy. The Debtor fails to identify any Bankruptcy Code provision allowing it to alter the rights of non-Debtor TIC owners. Given that the Debtor currently has no income and functions solely as a passive investment vehicle, the Court deems the reorganization effort objectively futile. 

Regarding subjective bad faith, the Court considers the totality of circumstances rather than relying on specific factors alone. Bad faith may be indicated if a debtor seeks to hold a single asset 'hostage' for speculative purposes. The Debtor possesses only one asset encumbered by secured claims, has no income or ongoing business activities, and lacks employees. Additionally, the Debtor's unsecured claims are minimal compared to the Noteholder's claim, further supporting the Court's finding of bad faith in the filing.

The Noteholder contends that the reorganization plan primarily involves a two-party dispute due to the lack of significant unsecured claims, a characterization the Debtor disputes, citing Nikki Providence Road's claim. However, courts have previously dismissed cases not based on the two-party nature but on the absence of significant unsecured creditors, as seen in Little Creek, which highlighted limited unsecured creditor involvement in similar circumstances. Nikki Providence's claim of approximately $750,000 is deemed insignificant compared to the Noteholder's claim of about $30 million, which fully encumbers the Debtor's 66% property interest.

The timing of the Debtor's bankruptcy filing, occurring just before a scheduled foreclosure sale and after unsuccessful attempts to halt state court actions, suggests bad faith. Although the Debtor claims it notified the Noteholder about its bankruptcy intent, the court recognizes that bankruptcy is often utilized to delay foreclosures, which alone does not indicate bad faith. Nonetheless, the Debtor's filing followed its failure in the receivership action, and it had no control over the property or its proceeds, leading to the conclusion that the filing aimed to delay the Noteholder's rights enforcement.

The absence of other Kinard factors does not negate the evidence of bad faith, which can manifest without egregious wrongdoing. The concept of subjective bad faith reflects a lack of good faith rather than outright ill will. Despite no explicit egregious conduct, the totality of circumstances indicates the Debtor's lack of good faith. Furthermore, the Debtor acknowledged it could not act on behalf of non-Debtor TICs, as Mr. Wheeler recognized that unanimous TIC Agreement actions were necessary for property management or sale, yet these actions were unlikely in the Chapter 11 process.

The Debtor's filing was seen as an attempt to hold its asset "hostage" to exploit bankruptcy protections for speculative purposes. Ultimately, the Court determined that the Debtor's actions reflected subjective bad faith sufficient for dismissal or conversion under the Carolin standard, concluding that dismissing the case is in the best interest of the creditors.

The Debtor possesses only one asset, fully encumbered by a lien held by the Noteholder, resulting in no equity in the Property. Therefore, no other creditors would receive distributions from a liquidation under Chapter 7. Due to the lack of assets, equity, and cash flow, the Debtor cannot propose a reasonable plan of reorganization as the sole participant in the bankruptcy case. The owners of the Shopping Center, seeking tax benefits from like-kind exchanges, are tenants in common, a rigid ownership structure as noted in In re Geneva ANHX IV. While the Court does not find malice in the Debtor's bankruptcy filing, it concludes that the filing lacked good faith, aimed at delaying the largest secured creditor, despite the Debtor's controlling member being aware of the absence of a feasible reorganization possibility.

The Noteholder successfully demonstrated that the Debtor meets the objective and subjective prongs of the Carolin test, warranting dismissal of the case under 11 U.S.C. § 1112(b). A separate order will be issued accordingly, in compliance with the statutory time frames for hearings and decisions on motions. The remaining ownership interests in the Property are held by GCK TIC, LLC (20.42%), DMF TIC, LLC (9.42%), and BCP TIC, LLC (3.93%). Although the Debtor contested the characterization of the case as single-asset, it appeared to concede to the applicability of single-asset rules, further confirmed by its counsel at trial.

The Debtor's potential right to distributions under the TIC Agreement is undermined by the fact that the TICs only made one distribution in 2017, yielding approximately $10,000 to the Debtor. Despite Mr. Wheeler, the controlling member of both the Debtor and BCP, expressing support for the Debtor, the unanimous consent required under the TIC Agreement is still lacking. The Court admitted Exhibit G into evidence despite the Noteholder's objection, finding it relevant, albeit not substantially significant to the decision. 

The Court determined that dismissal is appropriate under Section 1112(b) and did not delve into the Noteholder's request for relief from stay under Section 362(d), though it noted the Noteholder likely meets the standard for relief based on the Debtor's inability to provide adequate protection and the bad faith filing. Additionally, relief under Section 362(d)(2) is possible since the Debtor has no equity in the Property, and an effective reorganization is deemed unfeasible.