In re S-Tek 1, LLC

In re: S-Tek 1, LLC, Debtor.

No. 20-12241-j11

United States Bankruptcy Court, D. New Mexico

September 2, 2021

MEMORANDUM OPINION

Robert H. Jacobvitz, United States Bankruptcy Judge

Before the Court is creditor Surv-Tek, Inc.'s ("Surv-Tek") Second Amended Motion to Dismiss Chapter 11 Case Pursuant to Bankruptcy Code [11 U.S.C §] 1112(b)^[1] (the "Motion to Dismiss"). Doc 176. S-Tek 1, LLC ("Debtor") responded to the Motion to Dismiss. Doc. 185. The Court held a final evidentiary hearing on the Motion to Dismiss on July 23 2021. The parties and counsel who appeared at the hearing are noted in the record.

In the Motion to Dismiss, Surv-Tek asserts that Debtor's bankruptcy petition must be dismissed because 1) Debtor filed the petition in bad faith merely to gain a strategic litigation advantage, 2) Debtor's proposed plan is not confirmable on its face, and 3) Debtor's principal has falsely testified, demonstrating Debtor's bad faith in pursuing this bankruptcy case. The Court will deny the Motion to Dismiss.

FINDINGS OF FACT^[2], ^[3]

A. The Debtor and its Acquisition of its Business from Surv-Tek, Inc.

Debtor is a limited-liability company providing commercial and residential land surveying and platting services in New Mexico. Ex. 1. Randy Asselin and Christopher Castillo are the only members; Mr. Asselin is the managing member. Debtor employs approximately 15 employees.

In December 2018, Surv-Tek and Debtor entered into an agreement (the "Closing Agreement") whereby Debtor purchased substantially all of the assets of Surv-Tek.^[4] The parties to the Closing Agreement are Surv-Tek, Inc., as seller, and its sole shareholders Russ Hugg and Robbie Hugg, and S-Tek, as purchaser. Ex. 9. Under the Closing Agreement, Debtor purchased "all the assets and properties of [Surv-Tek] (i) including its name, business and goodwill, (ii) including all of the assets and properties listed on [Surv-Tek's] schedule of enumerated assets attached to [the Closing Agreement]. . . but excluding [Surv-Tek's] retained assets." Id. In addition to furniture, fixtures, equipment, computers, and trucks and vehicles, the Schedule of Transferred Assets attached to the Closing Agreement includes the rights in and use of Surv-Tek's phone number and fax number. Id. Surv-Tek's retained assets include Surv-Tek's "cash and accounts receivable for work completed prior to [c]losing." Id. Debtor assumed certain liabilities of Surv-Tek. Debtor did not assume the liabilities of Surv-Tek delineated in the Closing Agreement as "Company Retained Liabilities." Id.

The purchase price for the assets was $1, 800, 000, of which $250, 000 was payable as a cash down payment and $1, 550, 000 was payable in accordance with a promissory note to be executed at closing.

As contemplated by the Closing Agreement, at closing Debtor made the cash down payment and executed a promissory note (the "Note") payable to Surv-Tek in the original principal amount of $1, 550, 000. Ex. 9. Under the terms of the Note, Debtor agreed to pay $16, 440.15 per month to Surv-Tek from April 1, 2019 until the maturity date of April 1, 2029, at which time the entire balance was due in full unless due sooner as a result of acceleration of the amount due under the Note following a default. Debtor granted Surv-Tek a security interest in certain assets as collateral for the indebtedness under the Note, including Debtor's goods, furniture, equipment, inventory, contract rights, general intangibles, accounts, and accounts receivable. Id. The security interest also includes after-acquired property and proceeds. Id. In Debtor's schedules, it stated that the value of the collateral securing the debt is $350, 000.

The Closing Agreement memorialized an asset sale, not a stock sale. S-Tek, a limited-liability company, neither purchased Surv-Tek stock nor sold or transferred any stock or other securities in the transaction. After the sale, Russ Hugg and Robbie Hugg retained all the stock of Surv-Tek, Inc.

Christopher Castillo, one of Debtor's principals, understood from marketing materials for the sale that the Huggs were selling their business, Surv-Tek, Inc., not just the assets of the business. When they signed the Note on behalf of Debtor, Mr. Castillo and Mr. Asselin understood that they were purchasing the entire business of Surv-Tek, Inc.

B. The State Court Litigation and Adversary Proceeding No. 20-1074

In July 2019, Debtor sued Surv-Tek, Russ Hugg, Robbie Hugg, and STIF, LLC in the Second Judicial District Court of New Mexico (the "State Court") alleging fraud, negligent misrepresentation, material breach of contract, breach of contract, breach of good faith and fair dealing, equitable recovery, and violation of the Uniform Commercial Code. See AP 20-1074. That action (the "State Court Action") was styled S-Tek 1, LLC v. Surv-Tek, Inc., D-202-CV-2019-05359. Id. Surv-Tek answered the complaint and counter-claimed, alleging that Debtor failed to timely pay the Note, among other things. Id.

The State Court entered two orders relevant to the Motion to Dismiss. In the first order. entered October 2, 2020, the State Court found that Debtor had violated its orders to provide proof of insurance and financial statements to Surv-Tek. Ex. 9, pg. 308. The State Court fixed a deadline of October 7, 2020 for Debtor to come into compliance with its prior order and ordered that Debtor would "be sanctioned the sum of $250.00 per day for each day that it fails to be in compliance with the" court's orders to provide such information after a cure period.

In the second order, entered on October 21, 2020, the State Court ordered Debtor to "come current on all indebtedness due and owing under the . . . Note" in the amount of $180, 841.70 by 5 p.m. on November 2, 2020 and pay $16, 440.15 per month thereafter, or cease operating in competition with Surv-Tek and using the telephone number and website purchased from Surv-Tek. Ex. 9, pg. 310. Debtor did not pay $180, 841.70 by November 2, 2020 and did not cease its operations. Debtor and Surv-Tek then engaged in mediation but no agreement was reached.^[5] Debtor filed a motion asking the State Court to reconsider the second order on October 23, 2020 and briefing on the motion for reconsideration was complete on December 1, 2020. Debtor subsequently removed the State Court Action to this Court, initiating Adversary Proceeding 20-1074.

C. The Bankruptcy Petition, Schedules, Claims, and the Plan

Debtor filed a voluntary petition (the "Petition") under chapter 11 of the Bankruptcy Code on December 2, 2020 (the "Petition Date") and elected treatment under subchapter V. As of the Petition Date, Debtor had $33, 013.58 in cash and $203, 429.01 in accounts receivable.^[6]

On Schedule E/F, Debtor listed priority unsecured debts to the Internal Revenue Service ($33, 910) and the New Mexico Taxation and Revenue Department ($37, 492) and non-priority unsecured debts totaling $644, 481 to American Express ($15, 275), Citibank, N.A. ($12, 987), two law firms (Blackgarden Law and Guebert Gentile & Piazza - totaling $28, 003)), New Mexico Community Development Loan Fund ($97, 486), Ready Capital Corp. ($135, 000), and STIF, LLC ($356, 000 - scheduled as contingent, unliquidated and disputed). Debtor also listed a debt to Surv-Tek of $1, 535, 000, scheduled as contingent, unliquidated, and disputed, and stated that the value of the collateral securing the debt is $350, 000. Surv-Tek was the only creditor listed with a secured claim. Doc. 1.

Debtor did not schedule Salls Brothers Construction ("Salls Brothers") as holding a disputed claim its initial Schedule E/F because, according to Mr. Asselin as discussed further below, he had not verified to his satisfaction that the claim arose due to a mistake by S-Tek. Ex. 10, pg. 383. Before Surv-Tek filed its Second Amended Motion to Dismiss, Debtor amended Schedule E/F on June 11, 2021 to include a disputed, unsecured, unliquidated debt of $68, 000 to Salls Brothers. Ex. C.

Surv-Tek filed a proof of claim and amended proof of claim (the "Surv-Tek Claim") for $1, 768, 941.83 based on Debtor's alleged breach of the terms of the Note, asserting that the entire amount of the claim is secured by Debtor's assets. Claim 6-2. Surv-Tek also filed a proof of claim for $82, 898.30 for breach of a lease agreement between STIF, LLC and S-Tek. Claim 7-1, part 3, pg. 24.^[7]

Debtor filed a Chapter 11 Small Business Subchapter V Plan of Reorganization (the "Plan") in March 2021. Doc. 96. In the Plan, Debtor classifies Surv-Tek's claim in Class 3 and Class 5. Surv-Tek is the only claimant in those classes. Under Class 3, Debtor proposes:

Debtor will pay the secured claim of Surv-Tek, in an amount to be adjudicated, in equal monthly installments between the Initial Distribution Date and April 1, 2029. Surv-Tek's secured claim shall be the lesser of (a) the value of the collateral securing such claim or (b) the amount that the Court ultimately rules [Debtor] owes to Surv-Tek. Any amount of Surv-Tek's secured claim that is attributable to principal owed under the Surv-Tek Note shall accrue interest at 5% per annum from the Petition Date. Surv-Tek shall retain its lien in its collateral to the extent of its secured claim amount.

Under Class 5, Debtor proposes:

If the Court rules that the claim of Surv-Tek exceeds the value of the collateral pledged to secure such claim, then the remaining claim of Surv-Tek shall [be treated in Class 5 and will] be subordinated pursuant to 11 U.S.C. § 510(b) and shall receive no distribution." Ex. 1.

Filed as exhibits to the Plan are three sets of five-year projections of Debtor's revenue and expenses. Ex. 2. The three projections assume that the amount of Surv-Tek's secured claim is either $100, 000, $365, 000, or $600,...