Bad Faith Filing No Obstacle for Hotel Reorganization

The Bottom Line

The Bankruptcy Court for the Northern District of Texas found that the Chapter 11 bankruptcy filing of a single asset real estate entity (whose sole asset had recently been conveyed to it via a deed-in-lieu-of-foreclosure) was filed in bad faith, yet the court refused to grant the principal creditor’s motions to lift the automatic stay and dismiss the case. In re 1701 Commerce, LLC, 477 B.R. 652 (N.D. Tex. 2012). The court found that only through the bankruptcy court’s oversight could the value of the property be protected. Furthermore, dismissal of the case would not be in the public interest because it would allow litigation in state court to continue, dissipating assets, jeopardizing jobs, and undermining the city’s intention that the property be operated as a first class hotel.

What Happened

To purchase and refurbish a hotel at 1701 Commerce Street, Fort Worth, Presidio Hotel Fort Worth, L.P. (“Presidio”) granted a senior lien on the property to Dougherty Funding, LLC (“Dougherty”) and a junior lien on the property to Vestin Originations, Inc., which assigned the loan to three of its affiliates (“Vestin Affiliates”).

In 2011, Presidio told Dougherty and Vestin Affiliates that it was having financial difficulties. Vestin Affiliates created and assigned their interests in the loan to 1701 Commerce, LLC (“1701 Commerce”), a wholly owned subsidiary. When Presidio defaulted on its loans, 1701 Commerce posted the property for a foreclosure sale; on the day of the foreclosure, Presidio transferred title to 1701 Commerce via a deed-in-lieu of foreclosure in exchange for a complete release from the junior loan.

Shortly thereafter, Dougherty posted the property for foreclosure, allegedly before it learned about the transfer. 1701 Commerce obtained a temporary restraining order in state court, where litigation regarding the respective rights of Dougherty, Vestin Affiliates, and 1701 Commerce under an intercreditor agreement was pending. On the evening prior to an evidentiary hearing on the restraining order, 1701 Commerce commenced its bankruptcy case under Chapter 11.

Dougherty filed a motion for relief from the automatic stay under section 362(d) of the Bankruptcy Code and a motion to dismiss under section 1112(b)(4). The court denied both motions. The court reasoned that relief from the stay is only allowed under section 362(d)(2) where the debtor has no equity in the property and where the property is not necessary for an effective reorganization. Transfer of title from Presidio to the debtor had extinguished the junior lien, leaving the debtor with equity in the property because there was no dispute that the value of the property exceeded the amount due on the senior lien. The court ordered the debtor to provide adequate protection but refused to lift the stay.

The court then turned its attention to the motion to dismiss. Under section 1112, courts regularly dismiss cases filed in bad faith, and the court noted that a number of the case law-derived factors indicative of bad faith were present here, including that the debtor had only a single asset; the debtor has no employees, as the hotel was run by a separate hotel management company; the debtor filed for bankruptcy on the eve of a state court hearing regarding its restraining order, raising an inference that the filing was done to evade state court orders and avoid foreclosure; and the debtor was a single-asset entity created on the eve of foreclosure, raising an inference that debtor was created to protect its parents from exposure. The court also pointed out that this case was, in fact, an inter-lender dispute between junior and senior lienholders, which should be settled in state court, rather than an actual bankruptcy. Given all these factors, the court found that debtor filed its Chapter 11 petition in bad faith.

Despite its finding of bad faith, the court refused to dismiss the case. Relying on In re Mirant Corp., 378 F.3d 511 (5th Cir. 2004) and N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513 (1984), the court stated that deciding whether to grant the motion also requires an examination of the interests of others. The court held that the public interest was not served by dismissing the case. The city of Fort Worth had granted financial support to the property in the form of a tax agreement, conditioned upon the property’s continued operation as a hotel, because the city’s Planning Department believed the city needed more first-class hotels; as such, it had an interest in the continued operation of the hotel. Additionally, the employees of the non-debtor hotel management company had a similar interest in the continued operation of the hotel.

If the case were dismissed, the parties would return to state court, making the property “serve as a fraying rope in a continuing tug of war” between the parties. 477 B.R. at 659. The end result would likely be a diminution in the estate’s value and its inability to function as a first-class hotel, perhaps even jeopardizing the jobs of the hotel’s employees. Better, the court said, for 1701 Commerce to remain in bankruptcy, where the bankruptcy court can monitor the administration of Presidio, oversee the debtor’s operations, enforce the automatic stay to protect property of the estate, and even appoint a trustee to manage the property. In bankruptcy, the property would be “insulated from the harm it could suffer as the focus of lawsuits in other forums.” Id. at 660.

Why This Case Is Interesting

This case deserves attention for the court’s use of the protections of the Bankruptcy Code to balance the public interest against the competing interests of the two lenders (who were the principal creditors of the debtor). While the court recognized that bankruptcy was inappropriate as the forum for dispute between the direct debtor and creditor parties, it nevertheless broadly interpreted the “parties” whose interests it should consider and used the powers granted it by the Bankruptcy Code to resolve the dispute between the lenders while protecting Presidio and its operation as a hotel for the public interest and third parties impacted by the hotel’s operations.