In re Diamondhead Casino Corp.

In re: DIAMONDHEAD CASINO CORPORATION, Alleged Debtor.

Case No. 15-11647(LSS)

UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE

June 7, 2016

Chapter 7

OPINION¹

This is the second opinion in this case, which began as an involuntary petition filed against Diamondhead Casino Corporation ("Diamondhead" or the "Company") by three stockholders/noteholders. Soon after the involuntary petition was filed, these petitioning creditors moved for the appointment of a chapter 7 trustee during the gap period. For the reasons set forth in the first opinion, that motion was denied after an evidentiary hearing.²

Now, the Court is faced with the alleged debtor's motion to dismiss the involuntary petition ("Motion to Dismiss").³ After a second evidentiary hearing and post-hearing briefing, the Court grants the motion. As became evident in the first evidentiary hearing and solidified in the second, the petitioning creditors' primary purpose in filing this case was to effect a change in management, and their secondary purpose was to collect a debt. On the facts of this case, neither of these goals serves a proper bankruptcy purpose.

Procedural Background

On August 6, 2015, David A. Cohen, Arnold J. Sussman, and F. Richard Stark (the "Original Petitioning Creditors") filed an involuntary petition against Diamondhead. OnSeptember 11, 15, and 17, respectively, Robert F. Skaff, David J. Towner, and DDM Holdings, LLC (collectively, and together with the Original Petitioning Creditors, the "Petitioning Creditors") joined the involuntary petition.

On August 28, 2015, Diamondhead filed the Motion to Dismiss. While that motion was pending, the Petitioning Creditors filed an emergency motion seeking the appointment of an interim trustee ("Trustee Motion"). Following a status conference, the parties agreed that the Court should hear the Motion to Dismiss after hearing the Trustee Motion. An evidentiary hearing on the Trustee Motion was held on October 16 and 20, 2015, and the Trustee Opinion issued denying the motion.

On September 17, 2015, the Petitioning Creditors filed their opposition to the Motion to Dismiss. An evidentiary hearing was held on January 15, 2016. At the hearing on the Motion to Dismiss, the alleged debtor presented the further live testimony of Ms. Deborah Vitale, Diamondhead's Chief Executive Officer. Additionally, the parties agreed to include in their post-hearing submissions, designations and counter-designations of deposition testimony. They also incorporated into the hearing on the Motion to Dismiss all the evidence presented in connection with the Trustee Motion.⁴

On February 5, 2016, Diamondhead filed its post-hearing opening brief.⁵ On February 26, 2016, the Petitioning Creditors filed their post-hearing answering brief.⁶ And,on March 10, 2016, Diamondhead filed its post-hearing reply brief.⁷ This is the Court's ruling.

Jurisdiction

The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 1334 and 157(a) and (b)(1). A motion to dismiss an involuntary petition is a core proceeding pursuant to 28 U.S.C. §§ 157(b)(2)(A) and (O).

Factual Background

None of the additional evidence adduced on the Motion to Dismiss causes the Court to question the factual conclusions reached in the Trustee Opinion. Accordingly, except to briefly reset the stage, the Court will elaborate upon and make further factual findings necessary for this opinion, but will otherwise rely upon the factual findings in the Trustee Opinion, all of which are incorporated herein.

I. Brief Re-cap of the Trustee Decision

Prior to August of 2000, Diamondhead operated ship-based gambling operations primarily out of ports located in Florida. In August 2000, Diamondhead divested itself of its ship-based operations and began to focus on the development of a land-based casino resort in Diamondhead, Mississippi. Since 2000, it has had no operations. Aside from a small amount of cash, Diamondhead's only tangible asset is its wholly owned subsidiary, Mississippi Gaming Corporation, which owns 404 acres of undeveloped land off of Interstate 10 in Diamondhead Mississippi (the "Property"). Since 2000, Diamondhead has sought to develop the Property into a destination resort centered around a casino. However,Diamondhead has never and does not currently have the financial wherewithal to develop the Property. Instead, it will need to raise funds or find a joint venture partner to attain this goal.

In 2010, pursuant to a private placement memorandum, the Company completed two rounds of financing. Diamondhead raised $475,000 in March 2010 and another $475,000 in November 2010.⁸ In exchange, the Company signed promissory notes, with maturity dates two years from issuance and interest at either 9% or 12%, as applicable (collectively, the "2010 Notes," and each a "2010 Note").⁹ The 2010 Notes are also convertible into equity under certain circumstances. Each of the 2010 Notes has matured and the Company has not paid them.

II. Additional Factual Background

A. Prepetition Events

Notwithstanding the Company's failure to develop the Property or to pay the 2010 Notes when they matured in 2012, there is no evidence that, prior to 2015, any of the Petitioning Creditors, or other investors or lenders, initiated litigation against Diamondhead. In 2014, however, several significant events occurred that were seen as troubling by one or more of the Petitioning Creditors.

First, in June 2014, the Securities and Exchange Commission temporarily suspended trading of Diamondhead stock for failure to make required filings, and in September 2014, the stock was deregistered.¹⁰ At least some of the Petitioning Creditors were not, in the firstinstance, alerted of this event by Diamondhead.¹¹ The lack of communication as well as the failure to make required filings understandably caused significant concern.

Second, the Company granted a lien on the Property (the "Executives Lien") to Ms. Vitale and certain board members up to an aggregate amount of $2 million in order to secure outstanding amounts owed to them for past services, as well as to secure future obligations.¹² Ms. Vitale, in particular, demanded the Executives Lien, threatening to leave the Company if it was not granted.¹³ The Executives Lien was granted contemporaneously with the Company's granting of liens on the Property in connection with its 2014 round of financing.¹⁴ This was the first time the Property was encumbered. Certain of the Petitioning Creditors were enraged by the granting of the Executives Lien to Ms. Vitale and other insiders as both Ms. Vitale and Mr. Harrison had previously stressed that the Property should remain unencumbered.¹⁵

Third, Diamondhead's board ratified the Company's lease of a townhome owned by Ms. Vitale that served as the Company's headquarters.¹⁶ Ms. Vitale first requested rent in 2012 via a letter to the board of directors. In her letter, Ms. Vitale stated that the Company had been using her townhome rent free since at least 2001, and that if the Company did not want to pay rent, it could move out.¹⁷ As a result of her letter, the Company and Ms. Vitale entered into a month-to-month lease for the townhome effective as of September 1, 2011.¹⁸As disclosed in the 2014 Private Placement Memorandum, Ms. Vitale received $100,000 from funds raised in 2014 on account of rent owed.¹⁹

Fourth, Diamondhead refused certain Petitioning Creditors' requests to add any new members to the board. Diamondhead twice turned down Mr. Skaff's request to sit on the board, the last request being January 2015.²⁰ And later in 2015, after the Company's annual meeting (see below), Diamondhead once again refused to seat any new members on the board.²¹

Fifth, the Petitioning Creditors lost faith in management. Four of the Petitioning Creditors testified that, over the years, Diamondhead, and in particular, Mr. Harrison, continually represented to them that a deal to develop the property with various significant players in the casino industry was on the horizon.²² Mr. Harrison convinced at least one of the Petitioning Creditors to retain his investments, promising greater returns would materialize in the near future.²³ As the years passed, and Diamondhead did not reach a deal to develop the Property, frustration grew. It appears to have peaked in 2014.

In 2015, litigation began.

B. Litigation

(i) College Health and Investments, Ltd v. Diamondhead

On January 15, 2015, College Health and Investments, Ltd. ("College Health")²⁴ sued Diamondhead in the Superior Court of the State of Delaware in and for New CastleCounty.²⁵ In this lawsuit, College Health sought payment of its 2010 Note in the principal amount of $150,000.²⁶ Diamondhead did not pay the promissory note at maturity. Rather, on January 22, 2015, seven days after the filing of the lawsuit, Diamondhead notified College Health that it was exercising its right, pursuant to section 2.1 of the 2010 Note, to convert the principal and interest owed to College Health into Diamondhead common stock.²⁷

Consistent therewith, on February 11, 2015, Diamondhead filed a motion to dismiss the College Health lawsuit as moot, asserting that Diamondhead had tendered the relief requested by College Health.²⁸ On July 2, 2015, the Superior Court (William G. Carpenter, J) issued its Memorandum Decision denying Diamondhead's motion to dismiss. First, Judge Carpenter found that Diamondhead had defaulted on College Health's 2010 Note when the note matured and Diamondhead failed to pay amounts owed.²⁹

Second, Judge Carpenter acknowledged Diamondhead's right of conversion under section 2.1 of the note, but found that right limited to the time period prior to maturity. In particular, he found that in section 4.6 of the note, Diamondhead waived "any and all defenses it may have in the future with respect to [its obligation to pay the principal and interest as of the Maturity Date], except to the extent that (a) this Note has been converted into Common Stock in accordance with [section 2]...