In re: Joseph William Sullivan

• Court: United States Bankruptcy Appellate Panel for the Ninth Circuit
• Decided: December 9, 2014
• Docket: CC-14-1225-TaDKi
• Status: Unpublished

Opinion

FILED DEC 9 2014 1 NOT FOR PUBLICATION SUSAN M. SPRAUL, CLERK 2 U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT 3 UNITED STATES BANKRUPTCY APPELLATE PANEL 4 OF THE NINTH CIRCUIT 5 In re: ) BAP No. CC-14-1225-TaDKi ) 6 JOSEPH WILLIAM SULLIVAN, ) Bk. No. 8:14-bk-10711-CB ) 7 Debtor. ) ______________________________) 8 ) JOSEPH WILLIAM SULLIVAN, ) 9 ) Appellant, ) 10 ) v. ) MEMORANDUM* 11 ) WILLIAM HARNISCH; PECONIC ) 12 PARTNERS LLC; PECONIC ASSET ) MANAGERS LLC, ) 13 ) Appellees. ) 14 ______________________________) 15 Argued and Submitted on October 23, 2014 at Malibu, California 16 Filed - December 9, 2014 17 Appeal from the United States Bankruptcy Court 18 for the Central District of California 19 Honorable Catherine E. Bauer, Bankruptcy Judge, Presiding ________________________________ 20 Appearances: Sean A. O’Keefe of O’Keefe & Associates Law 21 Corporation, PC argued for Appellant Joseph William Sullivan; Y. David Scharf of Morrison 22 Cohen LLP argued for Appellees William Harnisch, Peconic Partners LLC, and Peconic Asset Managers 23 LLC __________________________________ 24 Before: TAYLOR, DUNN, and KIRSCHER, Bankruptcy Judges. 25 26 * This disposition is not appropriate for publication. 27 Although it may be cited for whatever persuasive value it may have (see Fed. R. App. P. 32.1), it has no precedential value. 28 See 9th Cir. BAP Rule 8013-1. 1 INTRODUCTION 2 Fifteen days after debtor Joseph Sullivan filed a 3 chapter 111 petition, Appellees, as holders of a large state 4 court judgment and related judgment liens, filed a motion to 5 dismiss the case as a bad faith filing. They contended that the 6 case was a two-party dispute and that Debtor improperly filed 7 solely to delay their collection efforts. They also argued that 8 Debtor lacked any reasonable probability of confirming a chapter 9 11 plan because Appellees would vote against it. 10 Debtor opposed the motion, supported by his declaration and 11 timely filed schedules, statement of financial affairs, and a 12 chapter 11 status report. In the status report, he outlined the 13 events leading to the filing of his petition, including 14 Appellees’ active efforts to execute on their judgment lien and 15 to seize his non-exempt assets, and stated his intent to file a 16 plan within the exclusivity period. The United States Trustee 17 did not file any papers in response to Appellees’ motion but 18 advised the bankruptcy court orally that it did not join in the 19 motion. 20 Notwithstanding the early state of the chapter 11 case and 21 the merely circumstantial nature of Appellees’ evidence, the 22 bankruptcy court granted Appellees’ motion, finding that Debtor 23 filed the case in bad faith without any possibility of confirming 24 a plan. Then, without considering or determining whether 25 dismissal or conversion of the case would be in the best 26 1 Unless specified otherwise, all chapter and section 27 references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and all “Rule” references are to the Federal Rules of Bankruptcy 28 Procedure, Rules 1001-9037. - 2 - 1 interests of creditors and the estate, the bankruptcy court 2 dismissed the case. Because we determine that the bankruptcy 3 court’s failure to consider the best interests of creditors and 4 the estate was an abuse of its discretion and further because we 5 determine that its finding of bad faith was in error on this 6 record, we REVERSE. 7 FACTS 8 Debtor filed his bare bones petition for relief under 9 chapter 11 on February 4, 2014. Eight days later he filed2 a 10 Chapter 11 Status Report and supporting declaration. 11 Chapter 11 Status Report 12 In the status report, Debtor presented his version of the 13 prepetition disputes and six years of litigation between Debtor 14 and Appellees in New York and the events immediately leading to 15 the petition. According to Debtor, he was employed until October 16 2008 as the Chief Operating Officer and Chief Compliance Officer 17 of appellees Peconic Partners, LLC and Peconic Asset Managers, 18 LLC (together, “Peconic”). He was also a member of Peconic 19 entitled to share in profits. He described Peconic as an 20 institutional investment manager and registered investment 21 adviser founded by appellee William Harnisch. 22 Disagreements arose, Debtor’s employment was involuntarily 23 terminated in late 2008, and litigation followed. Although 24 2 The status report filed as docket 17 on the bankruptcy 25 case electronic docket is not contained in the record provided by the parties in this appeal. We have exercised our discretion to 26 take judicial notice of documents electronically filed in the underlying bankruptcy case. See O’Rourke v. Seaboard Sur. Co. 27 (In re E.R. Fegert, Inc.), 887 F.2d 955, 957-58 (9th Cir. 1989); Atwood v. Chase Manhattan Mortg. Co. (In re Atwood), 392 B.R. 28 227, 233 n.9 (9th Cir. BAP 2003). - 3 - 1 Debtor recited some initial successes at the trial court level, 2 such successes were overturned on appeal and eventually Appellees 3 obtained a judgment of approximately $1.5 million that resolved 4 one of several counterclaims Appellees filed against Debtor. The 5 record contains no evidence that this judgment is 6 nondischargeable; it appears to be based exclusively on contract. 7 Debtor described the judgment as requiring that he repay to 8 Peconic a $1 million advance that Peconic made to him, with 9 interest. The judgment did not fully resolve the state court 10 litigation. Debtor stated that costs to continue litigation plus 11 entry of the judgment rendered him insolvent and that he filed 12 bankruptcy seeking a breathing spell to allow him time either to 13 reorganize his financial affairs through a plan of reorganization 14 or to effect a liquidation through a liquidating plan. 15 Debtor set forth his intent to resolve a tax issue that 16 could provide recovery of over $550,0003 for the estate; to 17 determine if and how to proceed with the remaining New York 18 litigation; and to analyze the costs and benefits to recover as 19 preferential transfers over $70,000 removed from Debtor’s bank 20 accounts by the sheriff as part of Appellees’ collection efforts 21 on the unstayed judgment and to deal with Appellees’ judgment 22 lien recorded against Debtor’s New York residence.4 Debtor also 23 stated his intent to file a plan and disclosure statement within 24 3 Debtor later increased his estimate of the potential tax 25 recovery to $850,000. When Debtor filed the status report he already had obtained court approval to retain a CPA to pursue the 26 recovery. 27 4 Appellees filed the judgment with the New York County Clerk 89 days prior to the petition date, and Debtor did not post 28 a bond to stop their collection efforts. - 4 - 1 the 120 day exclusivity period. 2 Debtor described his primary assets as consisting of: a 50% 3 interest in a residence owned in New York with his wife, with a 4 market value of approximately $700,000 and subject to a mortgage 5 and Appellees’ judicial lien (combined total of $2.2 million); 6 two 401K retirement accounts he claimed as fully exempt; and 7 three vehicles owned free and clear, which he intended to claim 8 as partially exempt. He estimated the total value of his assets 9 at $749,002, exclusive of the potential tax refunds, a possible 10 employment performance bonus, and pending claims against 11 Appellees. Exclusive of the judgment, Debtor estimated total 12 unsecured claims of $217,296. 13 Six days after filing the status report, Debtor filed his 14 schedules and statement of financial affairs. 15 Schedules and Statement of Financial Condition 16 The Debtor’s summary of schedules reflects $350,000 in real 17 property assets and $397,985 in personal property assets for 18 total assets of $747,985; secured debt of $2,007,347; unsecured 19 claims of $231,036; and total liabilities of $2,238,383, which 20 Debtor identified as primarily business debt, not consumer debt. 21 Debtor’s secured debt consisted of a $498,151 mortgage secured by 22 the New York residence and the $1,509,195 judgment. His 23 scheduled unsecured debt consisted of $52,208 on four credit 24 cards; $73,192 owed to three different law firms; $600 in 25 membership dues; $27.00 in unpaid utilities; and $105,000 in 26 personal loans from two individuals (Gerard Sullivan and Thomas 27 Sullivan, apparently members of Debtor’s family). 28 In his statement of financial affairs, among other things,

- 5 - 1 Debtor disclosed $875,000 in gross income in 2013 which included 2 $675,000 that he described as a gross settlement amount; $242,639 3 in IRA distributions taken in the two years preceding bankruptcy; 4 $249,000 paid to the IRS and Franchise Tax Board in November 5 2013; the pending litigation in New York and related entry of a 6 sister state judgment in California in November 2013; and 7 multiple restraining orders, account restrictions, and apparent 8 levies on behalf of Appellees in the two months preceding the 9 bankruptcy filing. Debtor also disclosed legal retainers of 10 $222,543 paid in the one year pre-filing, $98,000 of which was 11 paid by Gerard, Joseph, or Thomas Sullivan. Of the retainers 12 paid, $42,049 was for fees incurred pre-petition. 13 The day after Debtor filed his schedules and statement of 14 financial affairs, Appellees filed their motion seeking dismissal 15 of the case. 16 The Motion to Dismiss 17 Appellees’ motion5 sought dismissal of the case under § 1112 18 on the stated grounds that: (1) Debtor filed the petition in bad 19 faith – to “delay, hinder or interfere with enforcement” of 20 Appellees’ judgment; (2) Debtor had “no reasonable probability of 21 confirming a Chapter 11 plan”; and (3) the filing was a 22 “strategic move in a two-party dispute.” Motion, Dkt. #38 at 23 6:6-9. Appellees supplied no evidence in support of their 24 contentions beyond a request that the bankruptcy court take 25 judicial notice of the record in the New York litigation which 26 5 Appellees’ only support for the motion was a declaration 27 that authenticated and attached documents consisting primarily of documents filed by the parties at various stages of the six years 28 of litigation in New York. - 6 - 1 documented their litigation victory but failed to evidence either 2 a judgment that would be nondischargeable or any kind of 3 inappropriate litigation conduct by Debtor. 4 Lack of a confirmable plan 5 Appellees argued that Debtor’s chapter 11 case must be 6 dismissed based on the lack of any reasonable likelihood that 7 Debtor could propose a confirmable plan of reorganization.6 They 8 argued that they would not consent to any plan that proposed less 9 than 100% payment on unsecured creditors’ claims. 10 Two-party dispute and timing of petition7 11 Appellees also contended that Debtor’s case represented a 12 typical two-party dispute and that through the bankruptcy case 13 Debtor sought to collaterally attack final rulings in New York. 14 They argued that Peconic was the creditor most impacted by any 15 proposed plan and that the New York forum, not the bankruptcy 16 court, would best and adequately protect all parties and assure a 17 just and equitable result. Appellees made no attempt to explain 18 6 Appellees based this argument on In re C-TC 9th Ave. 19 P’ship v. Norton (In re C-TC 9th Ave. P’ship), 113 F.3d 1304, 1309-10 (2nd Cir. 1997) (“a Chapter 11 petition is not filed in 20 good faith unless it serves a valid reorganizational purpose”) (citing Marsch v. Marsch (In re Marsch), 36 F.3d 825, 828 (9th 21 Cir. 1994)). 22 7 For the balance of their arguments, and the factors identified and analyzed, Appellees relied on Marshall v. Marshall 23 (In re Marshall), 721 F.3d 1032, 1048 (9th Cir. 2013) (in considering bad faith as cause for dismissal, courts “may 24 consider any factors which evidence ‘an intent to abuse the judicial process and the purposes of the reorganization 25 provisions.’”); In re Leavitt, 171 F.3d 1219, 1225 (9th Cir. 1999) (dismissal with prejudice of chapter 13 case for bad faith 26 requires consideration of whether debtor misrepresented facts or manipulated the Bankruptcy Code, debtor’s history of filings and 27 dismissals, whether debtor “only intended to defeat state court litigation,” whether egregious behavior is present); and 28 In re Ellsworth, 455 B.R. 904, 917-18 (9th Cir. BAP 2011) (same). - 7 - 1 how the New York forum would protect anyone other than Appellees. 2 Misrepresentations/manipulation 3 As additional indication of Debtor’s alleged bad faith, 4 Appellees asserted that Debtor was less than forthright in his 5 filings in the bankruptcy case. In support, Appellees contended 6 that Debtor’s characterization of his debts as primarily business 7 debts, rather than consumer debts, was improper. Appellees 8 argued that the judgment debt was for repayment of funds Debtor 9 borrowed for personal or family purposes, that Debtor 10 mischaracterized this debt as a tax advance, and that the related 11 legal fees also were not business expenses. They provided no 12 case law support for their argument regarding characterization of 13 Debtor’s debts. Appellees also argued that Debtor lacked 14 substantial unsecured debt and that this suggested that Debtor 15 was abusing the system. 16 Other indicators of bad faith 17 Appellees also argued that Debtor’s failure to pay anything 18 toward the judgment prior to filing bankruptcy showed Debtor’s 19 bad faith. Finally, Appellees also contended that they would get 20 nothing under a plan by Debtor, there was no business to be 21 preserved, there were no jobs to be saved – and, thus, that there 22 was no proper purpose for Debtor’s case. Appellees failed to 23 explain how their business preservation arguments squared with 24 the fact that this is an individual chapter 11 case. 25 Conversion to chapter 7 not a proper option 26 Based on Appellees’ conclusion that Debtor’s debts were 27 primarily consumer debts, Appellees argued that a presumption of 28 abuse would arise under § 707(b) if Debtor were to seek

- 8 - 1 conversion of his case to chapter 7. Therefore, Appellees 2 summarily concluded, conversion to chapter 7 was not an option. 3 Appellees provided no case law to support this conclusion. 4 Debtor’s Opposition 5 Debtor opposed the motion and supported the opposition with 6 his declaration. Debtor described himself as a 57-year-old 7 resident of Seal Beach, California, employed as an investment 8 executive at a salary of $200,000 per annum. 9 Relying on the legal standard identified by the Ninth 10 Circuit in In re Arnold, 806 F.2d 937, 939 (9th Cir. 1986),8 and 11 citing In re Marshall, 298 B.R. 670, 680-81 (Bankr. C.D. Cal. 12 2003), Debtor argued that the “good faith inquiry ‘is essentially 13 directed to two questions: (1) whether the debtor is trying to 14 abuse the bankruptcy process and invoke the automatic stay for 15 improper purposes; and (2) whether the debtor is really in need 16 of reorganization.’” Opposition, Dkt. #68 at 14:13-16. Debtor 17 stated that he was forced to file bankruptcy to obtain a 18 breathing spell from Appellees’ aggressive collection efforts and 19 that he filed with the intent to prepare a fair and equitable 20 plan of reorganization. He argued that he was hopelessly 21 insolvent both from a balance sheet perspective and from his 22 inability to pay debts as they became due in light of the accrual 23 of 9% interest on the judgment ($150,000 annually) compared to 24 8 Debtor provided the following quote from the Ninth 25 Circuit’s decision in In re Arnold: “The existence of good faith depends on an amalgam of factors and not upon a specific fact. 26 The bankruptcy court should examine the debtor’s financial status, motives, and the local economic environment. . . . Good 27 faith is lacking only when the debtor’s actions are a clear abuse of the bankruptcy process.” 806 F.2d at 939 (internal citation 28 omitted). Opposition, Dkt. #68 at 14:9-11. - 9 - 1 his current before-tax annual salary of $200,000. Debtor also 2 argued that through the bankruptcy filing he sought to preserve 3 the home he owned in New York with his wife. 4 As to Appellees’ specific allegations of bad faith factors, 5 Debtor responded as follows: 6 Plan confirmability 7 Debtor primarily argued that consideration of confirmability 8 of a plan not yet filed was premature and placed an improper 9 burden on him at such an early stage of the case. Debtor argued 10 that despite Appellees’ contention that they will thwart any plan 11 the Debtor files, “[f]requently even the most obstreperous of 12 creditor ultimately finds common ground with the debtor later in 13 the case.” Opposition, Dkt #68 at 15:1-2. In addition, Debtor 14 argued that ample law existed to justify separately classifying 15 the Appellees’ claim given their particular characteristics, 16 including receipt of a preferential transfer within 90 days prior 17 to the petition.9 18 Two-party dispute 19 Debtor argued that the bankruptcy case involved over 20 $400,000 in other claims and thus, factually, did not constitute 21 a two-party dispute. As to Appellees’ collateral attack 22 argument, Debtor argued that he did not seek to defeat the 23 validity of the judgment in the bankruptcy court, but would treat 24 the judgment under the plan in accordance with the Bankruptcy 25 26 9 In a footnote in the opposition, Debtor alleged that Peconic filed a transcript of the judgment with the Clerk of 27 Nassau County, New York, on January 17, 2014, which resulted in the creation of a lien in favor of Peconic on the residence in 28 New York owned by the Debtor with his wife. - 10 - 1 Code, including distributions and appropriate discharge of any 2 unpaid balance, “[u]nless and until the New York Judgment is 3 vacated in the course of a continuation of the New York Action.” 4 Id. at 18:10-11. 5 Alleged misrepresentations and the conversion option 6 Debtor argued that he properly categorized his case as a 7 non-consumer case. Because the debt resulted from a judgment on 8 a business dispute between employer and employee, Debtor argued 9 it had no consumer attributes. Thus, Debtor argued that 10 chapter 7 was clearly an option. 11 Other alleged bad faith indicators 12 Debtor argued that Appellees were wrong to contend that 13 Debtor had the ability to pay the judgment, especially in light 14 of the accruing interest. 15 Other arguments 16 Debtor finally argued that the Supreme Court’s decision in 17 Toibb v. Radloff, 501 U.S. 157 (1991), specifically held that an 18 individual is eligible to reorganize under chapter 11 despite the 19 lack of any ongoing business. Further, Debtor argued that his 20 filing was consistent with the objectives of the Bankruptcy Abuse 21 Prevention and Consumer Protection Action (“BAPCPA”): “to channel 22 individuals with higher levels of income and larger balance 23 sheets into Chapter 13, or Chapter 11.” Id. at 21:20-21. He 24 acknowledged in his opposition that § 1115, added by BAPCPA, 25 brings an individual chapter 11 debtor’s post-petition income 26 into the estate, and that § 1129(a)(15), also added under BAPCPA, 27 requires that he commit five years of projected disposable net 28 income to his plan effort.

- 11 - 1 Appellees’ Reply 2 On reply, Appellees responded that although they believed 3 Debtor was capable of paying all his debts, Debtor’s allegation 4 that he was insolvent established his inability to present a 5 confirmable plan, and thus the case should be dismissed.10 6 Appellees argued that the case was simple: Debtor “lives a lavish 7 lifestyle” and “filed this case in order to maintain his current 8 level of spending,” and concluded that, therefore, the case “does 9 not belong in bankruptcy.” Reply, Dkt. #77 at 9:7-14. 10 The bankruptcy court’s findings and conclusion 11 The hearing on the motion was set concurrently with Debtor’s 12 applications to employ two law firms, his motion for approval of 13 his budget, and a chapter 11 scheduling and management 14 conference. The bankruptcy court heard argument on the 15 Appellees’ motion first. Counsel for the United States Trustee, 16 who appeared but did not otherwise participate in the arguments, 17 advised the bankruptcy court that the United States Trustee did 18 not join in the motion. After oral argument by the parties, and 19 without allowing testimony or other additional evidence, the 20 bankruptcy court took the motion under submission and continued 21 the other hearings. Shortly thereafter, it issued its written 22 Statement of Decision and a separate order dismissing the case. 23 In the Statement of Decision the bankruptcy court held that 24 25 10 Appellees also argued against Debtor’s contention that Appellees’ judgment appropriately could be separately classified 26 and presented their assessment of Debtor’s legitimate debts and his inability to appropriately identify an impaired class capable 27 of accepting a plan over Appellees’ objection. And Appellees argued that Debtor’s arguments that his debts are not consumer 28 debts were unsupportable. - 12 - 1 the bankruptcy case was not filed in good faith. It stated that 2 “[t]he existence of good faith depends on an amalgam of factors 3 and not upon a specific fact,” criticizing Debtor’s argument that 4 his subjective good faith in filing the case was important. 5 Statement of Decision, Dkt. #93 at 2 n.1 (citing In re Arnold, 6 806 F.2d at 939). It identified as the appropriate test: 7 “whether a debtor is attempting to unreasonably deter and harass 8 creditors or attempting to effect a speedy, efficient 9 reorganization on a feasible basis.” Id. (again citing 10 In re Arnold, along with In re Marsh, 36 F.3d at 828). 11 The bankruptcy court then specifically found that: “It is 12 obvious that Debtor’s sole purpose for filing bankruptcy was to 13 stop Peconic from collecting on its judgment.” Id. at 3:1-3. As 14 supporting facts it stated that the case was a two-party dispute 15 filed after six years of litigation, only 89 days after judgment 16 was entered against the Debtor, and when Peconic had just begun 17 collection efforts. 18 In addition, the bankruptcy court found that “a confirmable 19 plan of reorganization is not possible since Peconic (by far the 20 largest unsecured creditor), has indicated that it will vote 21 against any plan of reorganization that does not propose to pay 22 unsecured creditors 100 percent of their claims.” Id. The 23 bankruptcy court referred to Debtor’s estimation in the bare 24 bones petition that there would be no funds available for 25 distribution to unsecured creditors; and it concluded that Debtor 26 could not artificially impair his mortgage lender because there 27 was no unsecured portion to impair. 28 The Debtor timely filed a notice of appeal to the BAP and an

- 13 - 1 emergency motion with the bankruptcy court for stay pending 2 appeal, which was denied. Debtor thereafter filed a motion with 3 the BAP for a stay pending appeal, which a motions panel granted. 4 JURISDICTION 5 The bankruptcy court had jurisdiction pursuant to 28 U.S.C. 6 §§ 1334 and 157(b)(2)(A). We have jurisdiction under 28 U.S.C. 7 § 158. 8 ISSUES 9 Whether the bankruptcy court abused its discretion when it 10 dismissed the bankruptcy case. 11 STANDARD OF REVIEW 12 We review the bankruptcy court’s decision to dismiss a case 13 under an abuse of discretion standard. Leavitt v. Soto 14 (In re Leavitt), 171 F.3d 1219, 1223 (9th Cir. 1999). We apply a 15 two-part test to determine whether the bankruptcy court abused 16 its discretion. United States v. Hinkson, 585 F.3d 1247, 1261-62 17 (9th Cir. 2009) (en banc). First, we consider de novo whether 18 the bankruptcy court applied the correct legal standard to the 19 relief requested. Id. Then, we review the bankruptcy court’s 20 fact findings for clear error. Id. at 1262 & n.20. See also 21 Eisen v. Curry (In re Eisen), 14 F.3d 469, 470 (9th Cir. 1994) 22 (the bankruptcy court’s finding of “bad faith” is reviewed for 23 clear error); St. Paul Self Storage Ltd. P’ship v. Port Auth. 24 (In re St. Paul Self Storage Ltd. P’ship), 185 B.R. 580, 582 (9th 25 Cir. BAP 1995) (same). We must affirm the bankruptcy court’s 26 fact findings unless we conclude that they are illogical, 27 implausible, or without support in the record. Hinkson, 585 F.3d 28 at 1262. We may view a factual determination as clearly

- 14 - 1 erroneous if it was without adequate evidentiary support or was 2 induced by an erroneous view of the law. Wall St. Plaza, LLC v. 3 JSJF Corp. (In re JSJF Corp.), 344 B.R. 94, 99 (9th Cir. BAP 4 2006). 5 DISCUSSION 6 The bankruptcy court dismissed Debtor’s case as a bad faith 7 filing based on two primary determinations: (1) its factual 8 finding that the case was a two-party dispute and that Debtor’s 9 sole purpose in filing was to stop Appellees’ collection efforts; 10 and (2) its legal conclusion that Debtor could not propose a 11 confirmable plan. These determinations are not supported 12 adequately by the record. Alternatively, the bankruptcy court 13 abused its discretion by dismissing the case without considering 14 whether conversion or dismissal would be in the best interests of 15 all creditors and the estate. 16 Section 1112(b)(1) provides in relevant part that ". . . the 17 court shall convert a case under this chapter to a case under 18 chapter 7 or dismiss a case under this chapter, whichever is in 19 the best interests of creditors and the estate, for cause 20 . . . ." 11 U.S.C. § 1112(b)(1). If cause is established, the 21 decision whether to convert or dismiss the case falls within the 22 sound discretion of the court. Mitan v. Duval (In re Mitan), 23 573 F.3d 237, 247 (6th Cir. 2009); Nelson v. Meyer 24 (In re Nelson), 343 B.R. 671, 675 (9th Cir. BAP 2006) (chapter 13 25 case). And, if a bankruptcy court determines that there is cause 26 to convert or dismiss, it must also: (1) decide whether 27 dismissal, conversion, or the appointment of a trustee or 28 examiner is in the best interests of creditors and the estate;

- 15 - 1 and (2) identify whether there are unusual circumstances that 2 establish that dismissal or conversion is not in the best 3 interests of creditors and the estate. § 1112(b)(1), (b)(2); and 4 see Shulkin Hutton, Inc., P.S. v. Treiger (In re Owens), 552 F.3d 5 958, 961 (9th Cir. 2009) (“the court must consider the interests 6 of all of the creditors”); In re Prods. Int'l Co., 395 B.R. 101, 7 107 (Bankr. D. Ariz. 2008). 8 A. The bankruptcy court abused its discretion when it failed to consider whether conversion or dismissal was in the best 9 interests of all creditors and the estate. 10 We determine as a preliminary matter that even if we 11 determine that the bankruptcy court’s findings of bad faith and 12 plan futility were not in error, the bankruptcy court abused its 13 discretion by failing to consider whether conversion or dismissal 14 was in the best interests of all creditors and the estate. We 15 also determine that on the current record this error was not 16 harmless. We begin here because clarification on this point 17 provides guidance in our analysis of the bankruptcy court’s other 18 determinations. 19 Appellees argue on appeal that dismissal was in the best 20 interests of creditors and that Debtor waived any contrary 21 argument because he did not raise it in his opposition to the 22 motion. We disagree. In the motion and opposition the parties 23 both argued as to whether chapter 7 was an available option for 24 the Debtor.11 And regardless of the parties’ arguments, the 25 11 Both sides focused their arguments, however, on whether 26 Debtor’s case would be subject to dismissal as an abuse pursuant to § 707(b) due to Debtor’s income level and the nature of his 27 debts. Appellees argued that Debtor mischaracterized his consumer debts as primarily business debts; Debtor argued to the 28 (continued...) - 16 - 1 bankruptcy court had an independent obligation under § 1112 to 2 consider what would happen to all creditors on dismissal and, in 3 light of its analysis, whether dismissal or conversion would be 4 in the best interest of all creditors, not just the largest and 5 most vocal creditor. See In re Owens, 552 F.3d at 961 (agreeing 6 with the Fourth Circuit that “when deciding between dismissal and 7 conversion under 11 U.S.C. § 1112(b), ‘the court must consider 8 the interest of all of the creditors.’”) (quoting Rollex Corp. v. 9 Assoc. Materials (In re Superior Siding & Window, Inc.), 14 F.3d 10 240, 243 (4th Cir. 1994)). 11 When determining the best interest of the creditors under 12 § 1112(b), the Code’s fundamental policy of achieving equality 13 among creditors must be a factor considered, “and it is not 14 served by merely tallying the votes of the unsecured creditors 15 and yielding to the majority interest.” In re Superior Siding & 16 Window, Inc., 14 F.3d at 243; and see In re Graphic Trade 17 Bindery, Inc., 2012 Bankr. LEXIS 1598 at *17 (Bankr. D. Md. 18 Apr. 12, 2012) (“the mere fact that a section 1112(b) motion 19 seeks only conversion is no bar to dismissal if the court 20 determines that dismissal is in the best interest of the 21 creditors and the estate. The opposite is also true. The task 22 of the bankruptcy court is to determine which option is the 23 better choice.”). 24 While we acknowledge that unsecured creditors did not take a 25 position here, it is notable that the United States Trustee made 26 clear that it did not support dismissal. 27 11 (...continued) 28 contrary. - 17 - 1 Based on our reading of the hearing transcript, it appears 2 that the bankruptcy court may have believed that its limited task 3 was to grant or deny the relief requested by Appellees – 4 dismissal. The bankruptcy court was not so limited. It had at 5 least three options available to it: let Debtor try to propose a 6 plan; convert the case to chapter 7; or dismiss it, as Appellees 7 requested. When considering these options, the bankruptcy court 8 was required to consider the unrefuted evidence that: 9 (1) Appellees had judgment liens and immediate collection 10 abilities superior to all of Debtor’s unsecured creditors upon 11 dismissal of the case; (2) Appellees’ judgment liens, however, 12 were subject to attack as preferences; (3) there was no evidence 13 that creditors other than Appellees had any avenue for prompt or 14 meaningful payment outside a bankruptcy case; (4) recovery of the 15 tax refund would be enhanced in either a chapter 11 or chapter 7 16 case; and (5) dismissal as a result of these factors was far less 17 advantageous than conversion for all creditors of the estate 18 other than Appellees. This was not harmless error. 19 We cannot determine from the record whether the bankruptcy 20 court believed that § 707(b) barred conversion to chapter 7, but 21 the Appellees certainly argued that this was the case. We 22 disagree; § 707(b) abuse analysis did not bar conversion on this 23 record. 24 There is a substantial body of decisional law12 focusing on 25 the applicability of § 707(b) when a debtor seeks to voluntarily 26 12 For an interesting survey of the majority, minority, and 27 hybrid approaches, see Anna Haugen, James C. Eidson and Amir Shachmurove, Should § 707(b) Apply in Chapter 7 Cases Converted 28 from Chapter 13?, 33-4 Am. Bankr. Inst. J. 48 (2014). - 18 - 1 convert a chapter 13 case to chapter 7 – and the courts are split 2 as to whether conversion under these facts is appropriate. We 3 located only one case discussing a debtor’s attempt to 4 voluntarily convert a chapter 11 case to chapter 7. See 5 In re Traub, 140 B.R. 286 (Bankr. D.N.M. 1992). We located no 6 case authority, and the parties cited none, addressing the 7 applicability of § 707(b) abuse analysis to chapter 7 cases 8 converted involuntarily from chapter 11. Dismissal under 9 § 707(b), however, requires the exercise of the bankruptcy 10 court’s discretion; the statute states that the bankruptcy court 11 “may” dismiss - dismissal is not required. 12 Further, the bankruptcy court’s ability to rely on § 707(b) 13 for dismissal requires a determination that the Debtor’s debts 14 were primarily consumer. Suffice it to say that this question 15 is, at best for Appellees, an open one. 16 Finally, we are aware of individual chapter 11 cases 17 converted to chapter 7 by court order after either failure by 18 debtors to achieve plan confirmation timely or as a result of 19 default under confirmed chapter 11 plans – none of which involved 20 “means test” or § 707(b) abuse consideration. We located nothing 21 in the record before the bankruptcy court to support a conclusion 22 that Debtor’s chapter 11 case would not be eligible for 23 conversion to chapter 7 in the event Debtor was not able to 24 confirm a plan because Appellees ultimately prevailed in a plan 25 objection based on their veto under § 1129(a)(8). 26 The bankruptcy court here failed to consider whether 27 dismissal or conversion was in the best interests of the 28 creditors and the estate. Conversion was and is a viable option

- 19 - 1 even if § 707(b) is applicable. And given the facts in the 2 record currently before us, we cannot conclude that the 3 bankruptcy court’s failure to consider conversion was harmless 4 error. The evidence strongly suggests that conversion is in the 5 best interest of all creditors other than Appellees. Thus, the 6 bankruptcy court erred in this regard. 7 B. The bankruptcy court erred when it found the Debtor filed 8 this case not in good faith. 9 The bankruptcy court has broad discretion in determining 10 what constitutes "cause" under section 1112(b). See Chu v. 11 Syntron Bioresearch, Inc. (In re Chu), 253 B.R. 92, 95 (S.D. Cal. 12 2000). The movant bears the burden of establishing by a 13 preponderance of the evidence that cause exists. StellarOne Bank 14 v. Lakewatch LLC (In re Park), 436 B.R. 811, 815 (Bankr. W.D. Va. 15 2010). Because good faith is required in the commencement and 16 prosecution of a chapter 11 case, “the lack thereof constitutes 17 ‘cause’ for dismissal under § 1112(b)(1).” In re Mense, 509 B.R. 18 269, 276 (Bankr. C.D. Cal. 2014) (citing In re Marsch, 36 F.3d at 19 828 (“Although section 1112(b) does not expressly require that 20 cases be filed in ‘good faith,’ courts have overwhelmingly held 21 that a lack of good faith in filing a Chapter 11 petition 22 establishes cause for dismissal.”)). “The good faith requirement 23 ‘deter[s] filings that seek to achieve objectives outside the 24 legitimate scope of the bankruptcy laws.’” Id. 25 The bankruptcy court found that the bankruptcy case was a 26 two-party dispute with no possibility of plan confirmation and 27 was filed for the sole purpose of stopping Appellees’ collection 28 on their judgment. The limited record then before the bankruptcy

- 20 - 1 court in the early stages of the case does not support these 2 findings and conclusions. 3 1. The bankruptcy court erred by finding Debtor’s sole and bad faith purpose was to stop Appellees’ collection 4 efforts. 5 It is well recognized that the automatic stay under § 362, 6 activated upon filing a bankruptcy petition (with some exceptions 7 not applicable here), is intended to provide debtors in 8 bankruptcy with a breathing spell from their creditors’ 9 collection actions. And it is not unusual to encounter a 10 chapter 11 case filed “because of the crushing weight of a 11 judgment.” In re Marshall, 298 B.R. at 683. If, however, a 12 debtor seeks to use a chapter 11 filing to “unreasonably deter 13 and harass creditors,” such a filing lacks good faith. 14 In re Marsch, 36 F.3d at 828. 15 The bankruptcy court here found that Debtor filed his 16 chapter 11 case solely to stop Appellees’ collection efforts and 17 concluded that this constituted bad faith. The bankruptcy court 18 made no finding that stopping Appellees’ collection efforts was 19 unreasonable or was intended to harass Appellees, however, and we 20 find no support in the record for such inferences. 21 Based on Debtor’s schedules and statement of financial 22 affairs, for at least the two years preceding the bankruptcy 23 filing, Debtor supplemented his salary with substantial 24 withdrawals from retirement accounts, credit cards, and 25 significant loans from family members. Then two months before 26 filing, Appellees commenced aggressive collection efforts, 27 freezing or levying against bank and brokerage accounts. The 28 Debtor concurrently continued to incur substantial legal fees.

- 21 - 1 As stated in Debtor’s declaration in opposition to the motion, 2 which was not disputed by any evidence submitted by Appellees, 3 the litigation costs, entry of the judgment, and unpaid legal 4 bills left him insolvent. Appellees’ contrary argument that 5 Debtor was solvent and could and should have paid Appellees’ 6 judgment is not supported by the record. 7 At oral argument, the bankruptcy court expressed its 8 disbelief13 in assertions by Debtor that he was financially 9 strapped prepetition, when he had a house in New York that he 10 planned to keep and three high-end vehicles – unlike the people 11 the bankruptcy court was “used to” – “people who literally are 12 living in homeless shelters.” Hr’g Tr. (Apr. 9, 2014) at 13 17:22-23. The bankruptcy court directed argument away from 14 Debtor’s alleged insolvency,14 as a “non-issue.” Id. at 15:17. 15 As articulated by the Ninth Circuit, however, when assessing a 16 debtor’s good faith the bankruptcy court “should examine the 17 debtor’s financial status [and] motives. . . .” In re Arnold, 18 806 F.2d at 939. Here, the bankruptcy court’s disinclination to 19 examine the Debtor’s financial status beyond his possession of a 20 home in New York and three admittedly valuable vehicles 21 22 23 13 The bankruptcy court told Debtor’s counsel “don’t tell 24 me this gentleman is impoverished, please.” Hr’g Tr. (Apr. 9, 2014) at 18:10-11. 25 14 Nonetheless Debtor’s counsel advised the bankruptcy 26 court that Debtor moved to California, not because he wanted to be 2,000 miles away from his wife, but because he had to do so 27 for employment. His wife remained in New York as a cancer survivor who had a network of people and medical caregivers 28 supporting her there. - 22 - 1 contributed to its erroneous conclusion.15 2 Debtor’s petition, filed within 8916 days of perfection of 3 Appellees’ judgment lien, not only appropriately provided Debtor 4 a breathing spell,17 it laid the ground work for another key goal 5 underlying the bankruptcy process, leveling the playing field for 6 other creditors of the estate. See In re Superior Siding & 7 Window, Inc., 14 F.3d at 243. Appellees appear to have obtained 8 their judgment lien within the preference period. Not 9 surprisingly, Appellees argued that they would be better off if 10 allowed to pursue collection on their judgment outside of the 11 bankruptcy case – absent the bankruptcy filing, Appellees would 12 have a substantial advantage over other creditors. 13 In addition, Debtor stated his clear intention to save 14 equity in the New York home, where his wife lived, and his desire 15 for orderly liquidation of assets if he could not propose a 16 confirmable plan. The record does not evidence that the 17 bankruptcy court considered either of these goals. But both 18 goals are legitimate reasons to file bankruptcy. See Warner v. 19 Universal Guardian Corp. (In re Warner), 30 B.R. 528, 529 (9th 20 21 15 As recently discussed by the Ninth Circuit, “bankruptcy law must apply equally to the rich and poor alike, fulfilling the 22 Constitution’s requirement that Congress establish ‘uniform laws on the subject of bankruptcies throughout the United States.’” 23 Hawkins v. Franchise Tax Bd. of Cal., 769 F.3d 662, 669 (9th Cir. 2014). 24 16 The record is not fully developed as to the mechanism by 25 which Appellees obtained lienholder status; it appears undisputed, however, that Debtor’s filing on February 4, 2014, 26 put Appellees’ lien status within the 90-day preference period. 27 17 At the hearing on the motion, Debtor’s counsel argued that the breathing spell benefit of the automatic stay was 28 negated here by Appellees’ quickly filed motion. - 23 - 1 Cir. BAP 1983) (Nothing in the Code prohibits the use of chapter 2 11 by debtors seeking to save their family home from 3 foreclosure); and In re Soundview Elite, Ltd., 503 B.R. 571, 580 4 (Bankr. S.D.N.Y. 2014) (“it is not bad faith to file a chapter 11 5 petition for the purpose of a more orderly liquidation.”). And 6 although Debtor had not filed a proposed plan as of the hearing 7 on the motion, Debtor argued that through the chapter 11 8 bankruptcy process he intended to seek recovery of as much as 9 $850,000 on overpayment of taxes. 10 All the evidence before the bankruptcy court indicated that 11 Debtor had significant financial need for protection under the 12 Bankruptcy Code. No evidence was presented from which the 13 bankruptcy court could infer that Debtor intended to unreasonably 14 deter or harass Appellees or any of his other creditors. 15 2. The existence of disputes between Debtor and Appellees does not render the case a two-party dispute filed in 16 bad faith. 17 “Petitions in bankruptcy arising out of a two-party dispute 18 do not per se constitute a bad-faith filing by the debtors.” 19 In re Stolrow’s, Inc., 84 B.R. 167, 171 (9th Cir. BAP 1988). 20 Courts that find bad faith based on two-party disputes do so 21 where “it is an apparent two-party dispute that can be resolved 22 outside of the Bankruptcy Court’s jurisdiction.” Oasis at Wild 23 Horse Ranch, LLC v. Sholes (In re Oasis at Wild Horse Ranch, 24 LLC), 2011 Bankr. LEXIS 4314 at *29 (9th Cir. BAP Aug. 26, 2011) 25 (emphasis added) (citing N. Cent. Dev. Co. v. Landmark Capital 26 Co. (In re Landmark Capital Co.), 27 B.R. 273, 279 (D. Ariz. 27 1983)); and see St. Paul Self Storage Ltd. P’ship, 185 B.R. at 28 583 (debtor’s only significant asset was a claim against one

- 24 - 1 creditor set to be tried in state court and bankruptcy court 2 supervision of debtor’s liquidation was not necessary to protect 3 other creditors). Typical bad faith two-party dispute cases may 4 involve delays on the eve of trial (litigation tactics), forum 5 shopping, new-debtor syndrome (special purpose entities), repeat 6 filers, and repeatedly delayed foreclosure sales. There are no 7 such common indicators here. 8 The evidence before the bankruptcy court established that 9 the parties were involved in six years of litigation in state 10 court prior to the petition date; Debtor was using exempt assets, 11 family loans, and credit card debt to fund the litigation and his 12 expenses; and Appellees started to aggressively collect on their 13 judgment. With assets of approximately $750,000 versus the 14 $1.5 million judgment, and interest accruing at 9% on the 15 judgment versus Debtor’s annual salary of $200,000, Debtor was 16 balance sheet and cash flow insolvent before considering living 17 expenses and other significant debt. Such numbers do not support 18 the bankruptcy court’s implicit determination that resolution 19 outside the bankruptcy court was preferable or even possible. 20 This was not a case where Appellees offered any kind of 21 settlement or any resolution of the judgment other than Debtor’s 22 full liquidation. Nor does the evidence support a conclusion 23 that the bankruptcy filing did not provide important protection 24 to other legitimate creditors by leveling the playing field. 25 “Good faith is lacking only when the debtor’s actions are a clear 26 abuse of the bankruptcy process.” In re Arnold, 806 F.2d at 939. 27 Keeping the Appellees from seizing all liquid assets ahead of 28 other creditors and bringing preferential transfers back into the

- 25 - 1 estate for the benefit of all creditors not only do not 2 constitute abuses of the bankruptcy process, they achieve primary 3 goals of the bankruptcy process. Nor did Appellees present any 4 evidence to support an inference that Debtor sought to have the 5 bankruptcy court act as an appellate court in connection with the 6 pending state court matters or to shift to the bankruptcy court 7 the decision making on claims in the state court litigation. 8 During oral argument on the motion, the bankruptcy court 9 repeatedly stated that Debtor had one creditor. Appellees argued 10 that Debtor’s scheduled debts were insignificant and questionable 11 – Appellees were most affected by the filing, and, implicitly, of 12 singular importance. To the contrary, Debtor’s schedules, which 13 the bankruptcy court acknowledged having reviewed, establish the 14 existence of significant debt owed to credit card companies, 15 attorneys, and family members. The bankruptcy court had no 16 evidence before it from which it could appropriately infer that 17 any of such debt was not legitimate. Nor did any evidence exist 18 to dispute Debtor’s contention that the interest accrual on the 19 judgment alone made his financial survival outside of bankruptcy 20 impossible. To conclude otherwise was not supported by the 21 record. 22 3. Appellees’ stated intention not to accept a less-than-100%- plan by Debtor, alone, does not support a conclusion that 23 Debtor filed the case in bad faith. 24 The bankruptcy court also found that Debtor could not 25 propose a confirmable plan because Appellees argued they would 26 vote against it. Many are the judgment creditors who gnash their 27 teeth (metaphorical or otherwise) in chagrin when their 28 collection campaign is stayed by a bankruptcy filing. Only

- 26 - 1 slightly less frequent are the immediate post-filing threats that 2 no quarter will be given. Such jeremiads, however, are not a 3 sufficient basis for a universal conclusion of plan futility. 4 And they certainly do not unequivocally establish the debtor’s 5 bad faith. Economic considerations and rationality often result 6 in resolution. 7 Here, the Appellees’ statements must be taken in context. 8 Debtor had not filed a plan, and Appellees, apparently, had not 9 had time to compare their possible treatment under a plan with 10 the certainly less favorable treatment in a chapter 7 case. It 11 is indeed possible that Appellees would elect chapter 7, 12 notwithstanding that they lose the opportunity to obtain any 13 access to Debtor’s post-petition income. It is further possible 14 that the tax refunds will not be more easily collected in a 15 chapter 11 case such that this factor does not support a 16 continuation in chapter 11. And it is certainly possible that 17 the Debtor will try to take advantage of his creditors rather 18 than dealing with them forthrightly as he promises. But the 19 possibility that the Appellees will not act in their economic 20 best interest, when the choice is correctly presented as not 21 being limited to dismissal or chapter 11, or that the Debtor will 22 act in a manner inconsistent with the only evidence before the 23 bankruptcy court, do not equate to bad faith. Here, the only 24 evidence is not supportive of bad faith and only suggestive of 25 plan futility. Indeed, it is worth noting that the Appellees’ 26 stated unwillingness to ever support Debtor’s plan was not 27 supported by declaratory evidence of any type. It is possible 28 that this is a reasoned response that would retain rationality

- 27 - 1 even if conversion is the alternative, but on this record it is 2 illogical to so assume. 3 Moreover, nothing in the record indicates that Debtor was 4 aware that Appellees would take such a position when he filed his 5 petition. And when the bankruptcy court ruled on the motion, 6 Debtor had not filed a proposed plan at all.18 In essence, the 7 bankruptcy court concluded, based on a very scant record, that 8 Debtor could neither propose the 100% plan Appellees demanded, 9 negotiate a consensual resolution, or cram down a lesser payout 10 plan.19 Such determinations were premature. 11 We note that Debtor acknowledged that his postpetition 12 earnings and net disposable income are available in a chapter 11 13 14 18 At oral argument, the bankruptcy court heard the Debtor to suggest that he would artificially impair the secured lender 15 on the New York property to obtain an impaired class to vote in favor of a future plan. The bankruptcy court included in its 16 findings, however, that the “New York property is worth more than what is owed to the secured lender, so there is no unsecured 17 portion to impair.” Statement of Decision at 2. We were unable to find support in the record for this finding. Debtor scheduled 18 50% of the estimated value of the New York residence as property of the estate due to his nonfiling wife’s joint interest, but it 19 is not clear from the schedules whether Debtor likewise scheduled 50% of the mortgage debt against the property or 100%. Nor did 20 we locate any evidence regarding the status of payments to the mortgage lender or whether Debtor’s nonfiling spouse contributed 21 to the mortgage payments or had independent assets or income. 22 19 The bankruptcy court referred to an estimate contained in Debtor’s petition itself that no funds would be available for 23 distribution after exempt property and administrative claims. In his appellate opening brief, Debtor undertook to explain in a 24 footnote that the “no distribution” box in the emergency petition, as referred to by the bankruptcy court, was checked 25 automatically by the software system used by counsel. As the bankruptcy court acknowledged at oral argument on the motion that 26 it had reviewed the schedules and other documents on the docket, which necessarily included Debtor’s multiple declarations, we 27 conclude that reliance on a checked box on the bare bones petition was insufficient grounds for the bankruptcy court to 28 conclude no plan could be confirmed. - 28 - 1 plan. Under § 502 of the Code, Appellees would not be entitled 2 to the 9% interest on their judgment postpetition,20 reducing the 3 amount required to be paid from Debtor’s not-insubstantial 4 $200,000 annual salary. Debtor proposed to seek a large recovery 5 from the IRS to contribute to plan payments. And Debtor’s 6 schedules disclosed not-insignificant amounts of exempt assets 7 that the Debtor could, if so inclined, commit to a chapter 11 8 plan payout. Such possibilities were neither discussed nor 9 considered nor given adequate time for development. 10 Although it is well within a bankruptcy court’s decision- 11 making authority to determine facial non-confirmability of a 12 proposed plan (such as when considering a motion for approval of 13 a filed disclosure statement21), determining the facial non- 14 confirmability of an unfiled plan so early in the case and absent 15 a fully developed record is not supportable. See Can-Alta 16 Props., Ltd. v. State Sav. Mortg. Co. (In re Can-Alta Properties, 17 Ltd.), 87 B.R. 89, 92-93 (9th Cir. BAP 1988) (lifting of the 18 automatic stay based on bad faith, where the court lacked 19 evidence of confirmability or feasibility of a plan and afforded 20 no opportunity for the debtor to amend the then existing plan to 21 respond to the court’s concerns, constituted an abuse of 22 discretion). 23 24 25 20 Section 502(b)(2) provides for the disallowance of a claim to the extent that “such claim is for unmatured interest.” 26 21 See e.g., In re Main St. AC, Inc., 234 B.R. 771, 775 27 (Bankr. N.D. Cal. 1999) (a court may disapprove of a disclosure statement if the plan to which it refers could not possibly be 28 confirmed). - 29 - 1 CONCLUSION 2 Based on the foregoing, we REVERSE. 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

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