Sullivan v. Harnisch (In re Sullivan)

522 B.R. 604

In re Joseph William SULLIVAN, Debtor.

Joseph William Sullivan, Appellant

v.William Harnisch; Peconic Partners LLC; Peconic Asset Managers LLC, Appellees.

BAP No. CC–14–1225–TaDKi.

Bankruptcy No. SA 14–bk–10711–CB.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and Submitted on Oct. 23, 2014.

Filed Dec. 22, 2014.

Sean A. O'Keefe of O'Keefe & Associates Law Corporation, P.C. argued for Appellant Joseph William Sullivan.

Y. David Scharf of Morrison Cohen LLP argued for Appellees William Harnisch, Peconic Partners LLC, and Peconic Asset Managers LLC.

Before: TAYLOR, DUNN, and KIRSCHER, Bankruptcy Judges.

OPINION

LAURA S. TAYLOR, Bankruptcy Judge:

INTRODUCTION

Fifteen days after debtor Joseph Sullivan filed a chapter 11¹ petition, Appellees, as holders of a large state court judgment and related judgment liens, filed a motion to dismiss the case as a bad faith filing. They contended that the case was a two-party dispute and that Debtor improperly filed solely to delay their collection efforts. They also argued that Debtor lacked any reasonable probability of confirming a chapter 11 plan because Appellees would vote against it.

Debtor opposed the motion, supported by his declaration and timely filed schedules, statement of financial affairs, and a chapter 11 status report. In the status report, he outlined the events leading to the filing of his petition, including Appellees' active efforts to execute on their judgment lien and to seize his non-exempt assets, and stated his intent to file a plan within the exclusivity period. The United States Trustee did not file any papers in response to Appellees' motion but advised the bankruptcy court orally that it did not join in the motion.

Notwithstanding the early state of the chapter 11 case and the merely circumstantial nature of Appellees' evidence, the bankruptcy court granted Appellees' motion, finding that Debtor filed the case in bad faith without any possibility of confirming a plan. Then, without considering or determining whether dismissal or conversion of the case would be in the best interests of creditors and the estate, the bankruptcy court dismissed the case. Because we determine that the bankruptcy court's failure to consider the best interests of creditors and the estate was an abuse of its discretion and further because we determine that its finding of bad faith was in error on this record, we REVERSE.

FACTS

Debtor filed his bare bones petition for relief under chapter 11 on February 4, 2014. Eight days later he filed² a Chapter 11 Status Report and supporting declaration.

Chapter 11 Status Report

In the status report, Debtor presented his version of the prepetition disputes and six years of litigation between Debtor and Appellees in New York and the events immediately leading to the petition. According to Debtor, he was employed until October 2008 as the Chief Operating Officer and Chief Compliance Officer of appellees Peconic Partners, LLC and Peconic Asset Managers, LLC (together, “Peconic”). He was also a member of Peconic entitled to share in profits. He described Peconic as an institutional investment manager and registered investment adviser founded by appellee William Harnisch.

Disagreements arose, Debtor's employment was involuntarily terminated in late 2008, and litigation followed. Although Debtor recited some initial successes at the trial court level, such successes were overturned on appeal and eventually Appellees obtained a judgment of approximately $1.5 million that resolved one of several counterclaims Appellees filed against Debtor. The record contains no evidence that this judgment is nondischargeable; it appears to be based exclusively on contract. Debtor described the judgment as requiring that he repay to Peconic a $1 million advance that Peconic made to him, with interest. The judgment did not fully resolve the state court litigation. Debtor stated that costs to continue litigation plus entry of the judgment rendered him insolvent and that he filed bankruptcy seeking a breathing spell to allow him time either to reorganize his financial affairs through a plan of reorganization or to effect a liquidation through a liquidating plan.

Debtor set forth his intent to resolve a tax issue that could provide recovery of over $550,000³ for the estate; to determine if and how to proceed with the remaining New York litigation; and to analyze the costs and benefits to recover as preferential transfers over $70,000 removed from Debtor's bank accounts by the sheriff as part of Appellees' collection efforts on the unstayed judgment and to deal with Appellees' judgment lien recorded against Debtor's New York residence.⁴ Debtor also stated his intent to file a plan and disclosure statement within the 120 day exclusivity period.

Debtor described his primary assets as consisting of: a 50% interest in a residence owned in New York with his wife, with a market value of approximately $700,000 and subject to a mortgage and Appellees' judicial lien (combined total of $2.2 million); two 401K retirement accounts he claimed as fully exempt; and three vehicles owned free and clear, which he intended to claim as partially exempt. He estimated the total value of his assets at $749,002, exclusive of the potential tax refunds, a possible employment performance bonus, and pending claims against Appellees. Exclusive of the judgment, Debtor estimated total unsecured claims of $217,296.

Six days after filing the status report, Debtor filed his schedules and statement of financial affairs.

Schedules and Statement of Financial Condition

The Debtor's summary of schedules reflects $350,000 in real property assets and $397,985 in personal property assets for total assets of $747,985; secured debt of $2,007,347; unsecured claims of $231,036; and total liabilities of $2,238,383, which Debtor identified as primarily business debt, not consumer debt. Debtor's secured debt consisted of a $498,151 mortgage secured by the New York residence and the $1,509,195 judgment. His scheduled unsecured debt consisted of $52,208 on four credit cards; $73,192 owed to three different law firms; $600 in membership dues; $27.00 in unpaid utilities; and $105,000 in personal loans from two individuals (Gerard Sullivan and Thomas Sullivan, apparently members of Debtor's family).

In his statement of financial affairs, among other things, Debtor disclosed $875,000 in gross income in 2013 which included $675,000 that he described as a gross settlement amount; $242,639 in IRA distributions taken in the two years preceding bankruptcy; $249,000 paid to the IRS and Franchise Tax Board in November 2013; the pending litigation in New York and related entry of a sister state judgment in California in November 2013; and multiple restraining orders, account restrictions, and apparent levies on behalf of Appellees in the two months preceding the bankruptcy filing. Debtor also disclosed legal retainers of $222,543 paid in the one year pre-filing, $98,000 of which was paid by Gerard, Joseph, or Thomas Sullivan. Of the retainers paid, $42,049 was for fees incurred pre-petition.

The day after Debtor filed his schedules and statement of financial affairs, Appellees filed their motion seeking dismissal of the case.

The Motion to Dismiss

Appellees' motion⁵ sought dismissal of the case under § 1112 on the stated grounds that: (1) Debtor filed the petition in bad faith—to “delay, hinder or interfere with enforcement” of Appellees' judgment; (2) Debtor had “no reasonable probability of confirming a Chapter 11 plan”; and (3) the filing was a “strategic move in a two-party dispute.” Motion, Dkt. # 38 at 6:6–9. Appellees supplied no evidence in support of their contentions beyond a request that the bankruptcy court take judicial notice of the record in the New York litigation which documented their litigation victory but failed to evidence either a judgment that would be nondischargeable or any kind of inappropriate litigation conduct by Debtor.

Lack of a confirmable plan

Appellees argued that Debtor's chapter 11 case must be dismissed based on the lack of any reasonable likelihood that Debtor could propose a confirmable plan of reorganization. They argued that they would not consent to any plan that proposed less than 100% payment on unsecured creditors' claims.

Two-party dispute and timing of petition⁶

Appellees also contended that Debtor's case represented a typical two-party dispute and that through the bankruptcy case Debtor sought to collaterally attack final rulings in New York. They argued that Peconic was the creditor most impacted by any proposed plan and that the New York forum, not the bankruptcy court, would best and adequately protect all parties and assure a just and equitable result. Appellees made no attempt to explain how the New York forum would protect anyone other than Appellees.

Misrepresentations/manipulation

As additional indication of Debtor's alleged bad faith, Appellees asserted that Debtor was less than forthright in his filings in the bankruptcy case. In support, Appellees contended that Debtor's characterization of his debts as primarily business debts, rather than consumer debts, was improper. Appellees argued that the judgment debt was for repayment of funds Debtor borrowed for personal or family purposes, that Debtor mischaracterized this debt as a tax advance, and that the related legal fees also were not business expenses. They provided no case law support for their argument regarding characterization of Debtor's debts. Appellees also argued that Debtor lacked substantial unsecured debt and that this suggested that Debtor was abusing the system.

Other indicators of bad faith

Appellees also argued that Debtor's failure to pay anything toward the judgment prior to filing bankruptcy showed Debtor's bad faith. Finally, Appellees also contended that they would get nothing under a plan by Debtor, there was no business to be preserved, there were no jobs to be saved—and, thus, that there...