Restructuring

During this mostly quiet week in restructuring, most of us are either away on vacation (think beach or ski) or home for the holidays, maybe back in our hometowns. For me, it’s always the latter, and home for the holidays is Virginia Beach, Virginia, where I sit while I write this blog post (alas, not the beach vacation some of you may be enjoying; my relatives live about 20 minutes from the beach and the high temperature this time of year is usually in the 40s). My parents, my three siblings and I moved here from New York City about 30 years ago, and my parents still live in the same house I grew up in — in the Kempsville neighborhood, Fairfield subdivision, about two blocks away from the Fairfield Shopping Center, which of course, became a hangout for teenage me and my friends. And this is where our restructuring story begins…

My well-meaning parents, knowing that what I do for a living has something to do with bankruptcy, sent me a clipping from the local newspaper a few months ago about the Fairfield Shopping Center being in bankruptcy. Very sweet of them to tie the world of my adolescence to my current world. But a few weeks ago, I read an interesting written decision out of the bankruptcy court from the Eastern District of Virginia dismissing that very chapter 11 case, and voila, I had the perfect holiday blog post.

The Facts

The debtor in In re Fairfield TIC, LLC¹ (the “Debtor”) was actually the 66.2296% owner of a tenant-in-common interest in the Fairfield Shopping Center, its only asset (with the remaining interest being held by three owners that did not file chapter 11 cases, apparently a tax-driven structure). The Fairfield Shopping Center was in default of a $30 million note that matured in October 2017, a problem because, as stipulated by the Debtor and the holder of the note (the “Noteholder”), the Fairfield Shopping Center had a present value of no more than $27 million. In February 2018, the Noteholder filed a complaint in state court requesting the appointment of a receiver to manage the Fairfield Shopping Center, and in March 2018, the court appointed a receiver. The Noteholder originally set a foreclosure sale for July 2018, but then delayed it and rescheduled it for October 2018. A few days before that sale, the Debtor filed its chapter 11 case in the Bankruptcy Court for the Eastern District of Virginia (Norfolk Division), and both the receiver and the Noteholder moved to dismiss the case under section 1112(b) of the Bankruptcy Code for cause on the basis that the Debtor did not file the petition in good faith.

The Standard for Dismissal

Section 1112(b) of the Bankruptcy Code² permits a court, upon request of a party in interest, to dismiss a chapter 11 case “for cause” and lists several enumerated bases for cause. Like some other jurisdictions (but not all jurisdictions), the Fourth Circuit has held that filing a petition in “bad faith,” although not enumerated in the statute, constitutes cause for dismissing a chapter 11 case. To warrant dismissal under section 1112(b), the Fourth Circuit requires a two-pronged showing of bad faith: objective (no reasonable possibility for reorganization) and subjective (intent to abuse, cause hardship, or delay creditors, without an intent or ability to reorganize), each to be considered in light of the “totality of the circumstances.”

The Bankruptcy Court’s Holding

Applying those two prongs, the Bankruptcy Court held that dismissal was warranted.

First, on objective bad faith, the court pointed to the fact that this was a single-asset case and the Debtor had no equity in the property. The Debtor’s single asset, a 66% interest in a real property, was fully encumbered by the Noteholder’s note. The Debtor had limited access to the Fairfield Shopping Center’s revenues, which were assigned to the Noteholder and also controlled by the receiver, and no real going concern to protect given the generally passive, investment nature of the ownership interests. Moreover, the Debtor could not even propose a valid chapter 11 plan or take certain other actions without the support of its fellow tenants in common, which did not file their own chapter 11 petitions.

The court distinguished several other single-asset real estate chapter 11 cases cited by the Debtor where courts did confirm a chapter 11 plan, on the basis that those did not involve parties filing motions to dismiss, that the debtors in those cases were not merely passive investors, or that the courts in that case were using a different test for dismissal (requiring a showing of one of the enumerated factors, unlike the Fourth Circuit, which recognizes bad faith as a requirement).

The Debtor did suggest some creative strategies for overcoming its challenges, but they were all dismissed by the Bankruptcy Court. The court rejected the Debtor’s outline of a plan that would bind the non-Debtor tenants in common to a restructured loan with the Noteholder, sell certain property to a neighboring shopping center, and pay unsecured creditors over time, noting that this plan “effectively seeks to pool the interests of all the [tenants in common] to satisfy [the Debtor’s] own Chapter 11 reorganization.” The court also rejected the Debtor’s suggestion that it had other refinancing and sale alternatives that would involve cooperation of the other tenants in common. It relied on evidence that the investor in control of the Debtor had tried unsuccessfully to find such other options over the last year, as well as the fact that despite a year having elapsed since the default, the other tenants in common did not seem to be supporting the Debtor. Despite it being the holiday season, the court did not seem to buy the “hope and a prayer” strategy.

Second, on the subjective bad faith prong, the Bankruptcy Court similarly found cause. It pointed to some of the same facts that supported the objective bad faith prong, including the existence of a single asset. It also pointed to the timing of the filing (less than a week before the scheduled foreclosure sale and after the Debtor failed to stop the receivership action) and agreed with the Noteholders that this was essentially a two-party dispute between the Debtor and the Noteholder. It noted the paucity of unsecured creditors — no employees and only a few other real claims (a potential litigation claimant and the real estate manager), all much smaller than the claim of the Noteholders. The Court rejected the Debtor’s argument that this could not be a two-party dispute given the litigation claim, finding that the standard was not whether it was actually a two-party dispute, but “whether the lack of significant unsecured creditors resembles a two-party dispute.” The court also rejected the Debtor’s argument that the lack of “egregious conduct,” malice, or real wrongdoing prevents a finding of bad faith.

Conclusion

This case could have gone either way. The Bankruptcy Court could have given the Debtor some time to see if one of its plans or strategies could ultimately bear fruit, including getting its fellow tenants in common to support one of them. It seems that the court was ultimately convinced by the nature of the two-party dispute (no employees and lack of other real creditors), the timing of the filing, and the fact of the tenancy-in-common relationship (where the chapter 11 filing was used to stop a foreclosure of the property owned by all tenants in common, where the other tenants in common were not actively supporting the Debtor). It was also bound by a Fourth Circuit decision espousing a broad view of the court’s ability to dismiss a chapter 11 case, a view not necessarily shared by all jurisdictions. All of this combined to deny the Debtor a holiday gift of some more time in chapter 11 to seek to preserve its property interest.

Postscript: It seems that the residents of Fairfield are not too impacted by their local shopping center’s brief foray into, and dismissal from, chapter 11. During my stay here, we’ve made several trips to the shopping center, drinking coffee at Starbucks, buying gifts at the T.J. Maxx and eating at the McDonald’s.  And there is a rumor that a batting cage is coming to the shopping center soon — something fun for my kids to do when we are here next year for the holidays. 

Happy Holidays from the Weil Bankruptcy Blog!