Ortega's Mexican Rest., LLC v. Happy Rock Merch. Solutions, LLC (In re Ortega's Mexican Rest., LLC)

Citation: 597 B.R. 442Docket: CASE No. 18-20306 (JJT); CASE No. 18-20308 (JJT) (Jointly Administered); ADV. PRO. No. 18-02036 (JJT)

Court: United States Bankruptcy Court, D. Connecticut; February 1, 2019; Us Bankruptcy; United States Bankruptcy Court

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Ortega's Mexican Restaurant, LLC initiated an adversary proceeding against Happy Rock Merchant Solutions, LLC, aiming to avoid and recover alleged fraudulent transfers, usury, and violations of the Connecticut Unfair Trade Practices Act (CUTPA). Happy Rock counterclaimed for a declaratory judgment on the validity, extent, and ownership of the Debtor's accounts receivable. Central to the dispute is a merchant sales agreement from July 11, 2017, which the Debtor contends was a loan, while Happy Rock asserts it was a purchase of accounts receivable. The Court has been tasked with determining the nature of the transaction and has concluded that it was indeed a purchase of accounts receivable.

Jurisdiction is established under 28 U.S.C. § 1334(b), with the Court referring the matter from the District Court pursuant to 28 U.S.C. § 157(a) and (b)(1). Counts 1 and 2 of the amended complaint are classified as core proceedings, while Counts 3-6 are non-core but related. The counterclaim from Happy Rock is also deemed a core proceeding.

The undisputed facts include that the Debtor is a Connecticut LLC, managed by Mr. Ortega, who entered into the Agreement with Happy Rock for $20,000 to purchase $27,600 of future receivables. A portion of the payment was allocated to settle a previous agreement with Happy Rock. Under the Agreement, the Debtor agreed to pay 19% of its daily receipts until the amount was fully paid, without a fixed repayment term. Payments were contingent on the Debtor's future sales, and in the event of default, Mr. Ortega personally guaranteed the Debtor's performance. The Debtor also entered a separate agreement with Paysmith Account Processing to manage the payment of receivables to Happy Rock.

The Paysmith account was designated as a 'special purpose' account for the Debtor to manage financial transactions with Happy Rock, which included access to balance and transaction information and a requirement to review the account monthly for errors. The Paysmith agreement outlined 'Error Resolution Procedures' for addressing transaction discrepancies and stated that it would be governed by New York law. Happy Rock filed a UCC-1 financing statement on April 24, 2017, covering a broad range of the Debtor's collateral, including accounts receivable and inventory. In case of default, the agreement allowed Happy Rock to file financing statements against the Debtor's assets. 

When approving the Debtor's previous merchant sales agreement, Happy Rock considered an application that revealed the Debtor's prior relationship with Can Capital, indicating an existing debt of $6,000. Happy Rock did not request a new application for the subsequent agreement but reviewed bank statements from April to June 2017. 

The Debtor and Mr. Ortega filed for Chapter 11 bankruptcy protection on March 5, 2018, with their cases jointly administered. Happy Rock has not filed a proof of claim in either case. The Debtor initiated an adversary proceeding on July 26, 2018, and after Happy Rock filed a counterclaim, the Court scheduled a pretrial conference. A key issue for the Court was determining whether the transaction was a loan or a purchase of accounts receivable, with the Debtor arguing it was a loan due to the immediate default upon execution of the agreement, which contradicted the representation required regarding existing cash advances.

The Debtor asserts that Happy Rock failed to conduct adequate due diligence to ascertain the Debtor's solvency and did not provide necessary account information, implying Happy Rock should have recognized the Debtor's insolvency. Happy Rock argues that the transaction was a purchase of accounts receivable rather than a loan, which is supported by New York law that presumes transactions are not usurious. The Court agrees with Happy Rock, emphasizing that to classify a transaction as a loan, the defendant must be unconditionally entitled to repayment. The Court evaluates three factors: the presence of a reconciliation provision, the term of the agreement, and recourse options in the event of bankruptcy.

1. **Reconciliation Provision**: The Court finds that the Debtor could review account balances online and correct errors, indicating a mechanism to adjust payments based on cash flow. This suggests the transaction is not a loan.
   
2. **Term of the Agreement**: The Agreement lacks a defined repayment period. The Debtor contends that payment became absolute upon execution due to simultaneous dealings with another capital company and being in default. The Court rejects this view, stating that interpreting the Agreement as automatically defaulting would render much of it meaningless, contrary to New York contract law principles.

3. **Recourse in Bankruptcy**: The Court notes that it is vigilant against significant inequalities in bargaining power and will scrutinize contracts for potentially exploitative clauses. 

Overall, the Court finds that the factors support the conclusion that the transaction in question is not classified as a loan under New York law.

The Court finds that the Agreement in question is for the purchase of accounts receivable rather than a loan. A key issue arises from a contradictory clause that allows for both discretionary and automatic declaration of default, creating ambiguity. As a result, the Court interprets this ambiguity against the drafter, consistent with New York's U.C.C. 1-304, which mandates good faith in contract enforcement. The Court emphasizes that Happy Rock must declare a default before seeking recourse for insolvency, meaning that the Debtor's bankruptcy does not automatically render the amount repayable. In assessing the relevant factors, the Court concludes that they collectively support the determination that the Agreement was not a loan. Additionally, the Court has jurisdiction over Counts 1 and 2 of the amended complaint, as the nature of the Agreement is critical to these counts. The parties have consented to the Court's jurisdiction and the final judgment regarding the Agreement's nature. The determination made does not resolve all counts in the complaint and is not appealable under 28 U.S.C. 158. A status conference is scheduled for February 26, 2019.