REYES RAMOS et al v. DROGUERIA CENTRAL, INC. et al

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IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF PUERTO RICO
In re: :
:
JOHN JAVIER REYES RAMOS, : Case No. 04-09168 (GAC)
:
Debtor : Chapter 13
___________________________________:
DECISION AND ORDER
The debtor, John Javier Reyes Ramos (“Reyes”), filed a
petition under Chapter 13 on September 1, 2004. Since that time
numerous issues have arisen between Reyes and a creditor, DC
Limited Partnership (“DC Limited”).
Prepetition, DC Limited acquired second and third mortgages
over six commercial properties located in Bayamon, Puerto Rico from
Drogueria Central. The second mortgage secures a mortgage note for
the principal amount of $750,000.00, plus interest at the rate of
8%, payable to the bearer and dated December 2, 1996. The third
mortgage secures a mortgage note for the principal sum of
$350,000.00, with interest at the annual rate of 8%, payable to the
bearer and dated December 18, 1997. Subsequently, DC Limited
acquired the first mortgage over the six commercial properties from
Banco Bilbao Vizcaya-Puerto Rico. This mortgage note is for the
principal amount of $850,000.00, plus interest at an annual rate of
10% and extends to any rents that are due and unpaid when the
obligations secured by the mortgage are demanded.
When DC Limited acquired the mortgages, the properties were
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owned by Farmacia La Nueva Modelo de Bayamon, Inc. (“La Nueva”).
Reyes was the sole shareholder and president of La Nueva. DC
Limited sought to foreclose the first mortgage in local court and
obtained a judgment in the principal amount of $646,944.23, plus
$24,086.95 in interest and $85,000.00 in attorney’s fees. DC
Limited also obtained an order and writ of attachment in the local
court against the rents received by La Nueva for a lease of part of
the property. A public auction was scheduled for December 19,
2001.
On December 18, 2001, La Nueva filed a voluntary petition
under Chapter 7, Case No. 01-13916. DC Limited sought relief from
the automatic stay and at the final hearing, the trustee and DC
Limited orally agreed that if the trustee was unable to sell the
property within six months, the stay would be lifted and DC Limited
would be free to foreclose the property. The agreement provided
that the trustee would pay $900,000.00 to DC Limited upon the sale
of the properties and DC Limited would renounce its second and
third liens. The agreement also recognized that DC Limited had a
valid security interest in the rents. The parties were directed to
submit a stipulation within fifteen days, but the parties never
executed a written agreement.
Pursuant to the agreement between the trustee and DC Limited,
the local court was notified that the commercial properties would
be sold and that the complaint for collection and foreclosure of
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the second and third mortgages was abandoned with prejudice as was
a counterclaim. The local court granted judgment according to the
terms and conditions of the stipulation.
The trustee was ultimately unable to sell the properties and
filed a notice of abandonment. DC Limited thereafter sought a
determination that the automatic stay was terminated and the Court
entered an order allowing DC Limited to continue with the
foreclosure sale. The local court scheduled a second foreclosure
sale for September 2, 2004.
On August 31, 2004, Reyes transferred the mortgaged properties
from La Nueva to himself without consideration. The deed did
indicate that the property was being “sold” to Reyes for
$841,031.18, but that the purchase price was being retained to pay
DC Limited. Subsequently, on September 1, 2004, Reyes filed the
present petition. The schedules make no mention of Reyes being in
possession of funds retained to pay DC Limited.
DC Limited seeks to prohibit Reyes’ use of cash collateral,
consisting of the rents obtained from the lease of the real
property. Since the time of DC Limited’s motion, Reyes has evicted
the lessor from the premises. As of November 1, 2005, this Court
has $46,048.70 on deposit pertaining to rents consigned with the
Court from the local court proceedings. Reyes filed a motion to
withdraw $5575.00 of the consigned funds (dkt. #98), which DC
Limited opposed, arguing that Reyes failed to identify expenses
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totaling this amount and that he failed to properly document them
(dkt. #112).
DC Limited also seeks relief from the automatic stay to
continue with the foreclosure sale. DC Limited claims that all
three mortgages are valid since the trustee in the La Nueva
bankruptcy failed to sell the properties and pay DC Limited the
stipulated amount. DC Limited claims that Reyes has engaged in bad
faith in breaching the agreement reached in the La Nueva bankruptcy
case. Likewise, DC Limited argues that the transfer of the
properties from La Nueva to Reyes is presumed to be fraudulent
under Puerto Rico law. DC Limited alleges that Reyes has
insufficient income to fund a feasible plan and that Reyes’ secured
debts, including the second and third mortgages, exceed the debt
limits of 11 U.S.C. § 109(e), making Reyes ineligible for relief
under Chapter 13. Likewise, Reyes’ amended plan is premised on the
rental income, which Reyes is no longer receiving since the
eviction of the tenant. DC Limited also objected to the
confirmation of a plan that Reyes proposed and seeks dismissal of
the case with prejudice based on the same arguments.
Reyes denies the validity of the second and third mortgages
and filed an adversary complaint on January 4, 2005, Adv. No. 05-
00004, naming Drogueria Central, the original holder of the second
and third mortgages, as a defendant. Nonetheless, Reyes requests
that if it is subsequently determined that he is ineligible for
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Chapter 13 relief based on the amount of the secured debt, that he
be allowed to convert to Chapter 11. Reyes admitted at a hearing
that the purpose of the transfer of the property to himself and
the filing of this petition was to stop the foreclosure, but
contends that he is engaged in a good faith effort to repay the
debt to DC Limited. Since the filing of the petition, Reyes
obtained higher paying employment, now earning $900.00 per week
(dkt. #74) and has found a buyer for three units of the property
for the sum of $785,000.00. Reyes filed an application to sell
these units (dkt. #125), which DC Limited opposed (dkt. #130)
because it understands that the sale will be free and clear of the
liens on all six units, when only three are being sold. DC Limited
also contends that Reyes has not fully disclosed the terms and
conditions of the sale and provided necessary documentation.
DISCUSSION
The preliminary issue before the Court is whether DC Limited
is entitled to relief from the automatic stay. DC Limited seeks
relief from the automatic stay under 11 U.S.C. § 362(d)(1) for
cause. DC Limited contends that Reyes’ bad faith or lack of good
faith in filing the petition constitutes cause for relief.
Directly related, DC Limited claims that Reyes transferred the
properties to himself with the intent to defraud DC Limited.
Bad faith in filing a bankruptcy petition is cause for relief
from stay under 11 U.S.C. § 362(d)(1). See In re Laguna Assoc.,
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Ltd. Partnership, 30 F.3d 734, 737 (6 Cir. 1994) and citations	th
therein; Duvar Apt., Inc. v. F.D.I.C. (In re Duvar), 205 B.R. 196
(B.A.P. 9 Cir. 1996); In re Walden Ridge Development, LLC, 292	th
B.R. 58 (Bankr. D.N.J. 2003); In re Cambridge Woodbridge
Apartments, L.L.C., 292 B.R. 832 (Bankr. N.D.Ohio 2003); In re
Harvey Road Assoc. VIII, 140 B.R. 302 (Bankr. D.Mass. 1992).
Courts generally consider a number of factors in determining
whether a petition has been filed in bad faith, including:
1. The debtor has few or no unsecured creditors;
2. The debtor has previously sought relief;
3. The petition was filed on the eve of foreclosure;
4. The foreclosed property is the sole or major asset of
the debtor;
5. The debtor has no ongoing business;
6. The debtor has no ability to reorganize;
7. The reorganization involves a two party dispute;
8. The corporate debtor was formed to effectuate the
filing.
In re Harvey Road Assoc. VIII, 140 B.R. at 305 (quoting In re
Bryan, 104 B.R. 554 (Bankr. D.Mass. 1989)). These factors were
fashioned to deal with a “new debtor syndrome,” in which a
corporate entity is created to receive title to real property on
the eve of foreclosure and then file a bankruptcy petition to
isolate the property and its creditors. Another court has stated
that a variety of factors should be considered, including:
(1) when the petition is filed merely as a litigation
tactic; (2) when the petition was filed solely to
frustrate the legitimate efforts of other parties to
enforce their rights; (3) when the debtor lacks a valid
reorganizational purpose; and (4) when the debtor’s sole
motive is to avoid a contract.
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In re Walden Ridge Development, LLC, 292 B.R. at 62. Still other
courts have indicated that rather than indicia counting, the
practice should be to look at the totality of the circumstances.
In re U.S. Advertising Inc., 131 B.R. 537, 540 (Bankr. D.R.I.
1991). This is consistent with the approach taken by the First
Circuit Court of Appeals in determining that good faith in seeking
to convert from Chapter 7 to Chapter 13, is a fact-intensive
determination made on a case-by-case basis. Marrama v. Citizens
Bank of Massachusetts (In re Marrama), 430 F.3d 474, 482 (1st Cir.
2005).
In the present case, DC Limited premises its request for
relief on its contention that Reyes’ bad faith is evidenced by the
transfer of the real properties to Reyes, on the eve of the second
foreclosure sale of these properties, without consideration. DC
Limited also contends that this violated the agreement reached in
the La Nueva bankruptcy, which allowed it to foreclose when the
trustee was unable to sell the properties for the agreed price.
While the Court agrees that this is indicia of bad faith,
other factors weigh in Reyes’ favor. In the present case, Reyes
has numerous unsecured creditors. He personally has not previously
sought relief, although he was responsible for the filing of La
Nueva’s petition. While the real properties are Reyes’ major
asset, he also has income with which to fund a plan. He is
presently earning $3600.00 monthly. Moreover, no corporate entity
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was formed in this case to take title to the real property. Based
on the testimony presented and the events that have occurred during
these proceedings, the Court finds that the petition was not filed
merely to frustrate DC Limited’s efforts to enforce its rights.
The Court concludes that Reyes has a valid reorganizational purpose
and that there is more than a remote possibility of a successful
reorganization. Reyes contends that DC Limited received the sum of
$282,000.00 in payments from the Chapter 7 trustee in the case of
La Nueva. Likewise, the sum of $46,048.70 from rents received,
which clearly is cash collateral pledged to DC Limited, is on
deposit with the Court, which can be used to provide adequate
protection to DC Limited. Finally, Reyes has proposed to sell
three of the properties for the sum of $785,000.00. If this sale
is consummated, most of the proceeds would go to DC Limited.
Moreover, there would be three remaining properties to satisfy the
remainder of DC Limited’s debt and perhaps some of the unsecured
debt. The Court notes that DC Limited has not contended that the
properties lack equity nor that they are not necessary to Reyes’
reorganization. At the present time, the Court can not conclude
that the petition was filed in bad faith.
DC Limited also argues that it is entitled to relief from stay
because Reyes is not eligible for Chapter 13 relief because his
debts exceed the limits of 11 U.S.C. § 109(e). Reyes disputes the
validity of the second and third mortgages and filed an adversary
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to contest their validity. If it is determined that the second and
third mortgages are not valid, eligibility for Chapter 13 will not
be an issue.
If on the other hand, the liens are valid, Reyes seeks to
convert to Chapter 11. The Bankruptcy Code provides, in relevant
part, that “at any time before the confirmation of a plan under
section 1325 of this title, on request of a party in interest or
the United States trustee and after notice and a hearing, the court
may convert a case under [chapter 13] to a case under chapter 11 or
12 of this title.” 11 U.S.C. § 1307(d). Reyes has properly
requested conversion as an alternative form of relief while the
eligibility determination is pending. See In re Hanson, 282 B.R.
240, 246 (Bankr. D.Colo. 2002). Should it be determined that Reyes
is ineligible for Chapter 13 relief, the conversion sought requires
notice and a hearing. Id. Thus, the Court will hold this issue in
abeyance until eligibility for Chapter 13 can be determined.
If Reyes is eligible for Chapter 13 relief, the proposed plan
will have to be amended to reflect his additional income, the
termination of the lease and the sale of a portion of the property,
if it is approved.
ORDER
WHEREFORE IT IS ORDERED that DC Limited’s requests for relief
from the automatic stay are denied without prejudice.
IT IS FURTHER ORDERED that DC Limited may seek to withdraw the
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funds on deposit with the Court, less the $5575.00 sought by Reyes,
as adequate protection. Reyes is granted twenty (20) days to
identify expenses totaling the $5575.00 sought and properly
document this amount.
IT IS FURTHER ORDERED that the motions to dismiss filed by the
Chapter 13 trustee and DC Limited, based on eligibility grounds,
are held in abeyance, pending a determination of the validity of
the second and third liens on the real property and if determined
to be valid, pending a determination of whether Reyes may convert
to Chapter 11.
IT IS FURTHER ORDERED that the application for sale of
property (dkt. #125) and the opposition (dkt. #130) will be
considered on Friday, March 3, 2006 at 1:30 p.m. in the United
States Bankruptcy Court, 300 Recinto Sur, Courtroom 3, San Juan,
Puerto Rico. At this hearing, Court will also hold a pre-trial
conference in Adv. 05-00004. The parties shall comply with the
original pre-trial order (dkt. #3) in Adv. No. 05-00004. This
order shall also be entered in the docket of Adv. 05-00004.
SO ORDERED.
San Juan, Puerto Rico, this 13th day of January, 2006.
/s/ Gerardo A. Carlo
__________________________
GERARDO A. CARLO
Chief, U.S. Bankruptcy Judge
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