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In re Northland Construction Co.

decided: July 26, 1977.


Appeal from the United States District Court for the Eastern District of Wisconsin. No. 76-B-1539 - Robert W. Warren, Judge.

Fairchild, Chief Judge, Tone, Circuit Judge, and Cale J. Holder, District Judge.*fn*

Author: Tone

TONE, Circuit Judge.

This is an appeal from the dismissal of a voluntary petition under Chapter X of the Bankruptcy Act, 11 U.S.C. § 501, et seq. The District Court affirmed the finding of the bankruptcy judge that the debtor, admittedly a shell corporation which received property solely for the purpose of invoking Chapter X, did not meet the "good faith" requirements of § 146, 11 U.S.C. § 546, as interpreted by this court in In re Loeb Apartments, Inc., 89 F.2d 461 (7th Cir. 1937). We affirm.

The facts are not in dispute. The shopping center property that is the debtor's sole asset was purchased and developed in 1960 by two couples, Ace and Eva Bernstein and David and Mary Cunningham, acting as individuals. In 1964 they mortgaged the property to secure a note to respondent Penn Mutual Life Insurance Company for $800,000. It was agreed that in the event of default Penn Mutual would look only to the security for payment of the unpaid balance. A second loan of $50,000 was made on the same terms in 1966. Financial difficulties of the property's major tenant eventually led to a default on the Penn Mutual loan payments and to the commencement of foreclosure proceedings in July 1974. A foreclosure judgment was entered by a Wisconsin court on October 21, 1975 in the sum of $681,064.99, and a sheriff's sale was set for August 2, 1976, approximately two weeks after the expiration of the redemption period.

During the pendency of the foreclosure proceedings, the individual owners took steps to salvage their investment. Through Northland, a shell corporation which the Bernsteins had used in the past for real estate business, they solicited new tenants and expended approximately $17,000 in renovating and altering the premises. On June 1, 1976, in anticipation of the filing of a Chapter X petition, the property was transferred to Northland by quitclaim deed. At the same time, Ace Bernstein was also attempting to arrange a refinancing. The best offer he could obtain, however, was for only $300,000, an amount which Penn Mutual refused to accept in satisfaction of its foreclosure judgment. Thus, on July 1, 1976, Northland filed a petition for reorganization under Chapter X, thereby gaining an automatic stay of the state foreclosure proceedings.

In its petition, Northland stated that the mortgaged property was its sole asset and that its liabilities were limited to the mortgage itself and real estate taxes on that property, which were then in arrears. It also stated that the property had a potential value of $1,500,000, and that a foreclosure sale would yield less than a quarter of that amount. Arguing that its shareholders' equity would be completely wiped out if there was a liquidation, Northland proposed a plan of reorganization in which there would be "[a] temporary moratorium on the payment of principal; [all] rent monies [would be] applied to taxes, mortgage interest, mortgage principal, and mortgage arrearages, in that order; and [no] rent monies would be used to pay compensation to any of debtor's officers or employees." After hearing evidence on the issue of good faith, the bankruptcy judge, in an opinion adopted by the District Court, dismissed the petition as not having been filed in good faith.

Under § 141, 11 U.S.C. § 541, the first determination to be made with respect to a Chapter X petition is whether or not it was filed in good faith. While § 146, 11 U.S.C. § 546, lists four instances in which good faith will be deemed lacking, the concept is a flexible one, which "enables the court to determine, on the particular facts presented, whether the financial, economic, and legal situation of the debtor is one within the contemplation of Chapter X." 6 Collier on Bankruptcy para. 6.07 at 1041, 1045 (14th ed. 1977).

Some courts have adopted the view that good faith can never exist when an individual*fn1 organizes a corporation solely for the purpose of obtaining relief under Chapter X, because that chapter "was enacted for the purpose of facilitating the reorganization and rehabilitation of going corporate businesses." In re Metropolitan Realty Corp., 433 F.2d 676, 679 (5th Cir. 1970), cert. denied, 401 U.S. 1008, 28 L. Ed. 2d 544, 91 S. Ct. 1251 (1971). Mongiello Brothers Coal Corp. v. Houghtaling Properties, Inc., 309 F.2d 925 (5th Cir. 1962); Milwaukee Postal Building Corp. v. McCann, 95 F.2d 948 (8th Cir. 1938); 6 Collier on Bankruptcy, supra, para. 6.07 at 1048 n.30. This court, however, has not adopted such an immutable rule. In re Loeb Apartments, Inc., supra, 89 F.2d 461. Compare In re Knickerbocker Hotel Co., 81 F.2d 981 (7th Cir. 1936), with In re North Kenmore Building Corp., 81 F.2d 656 (7th Cir. 1936). In Loeb Apartments, 89 F.2d at 463, on which the debtor here relies heavily, the court outlined the test of good faith as follows:

"If it is obvious that a debtor is attempting unreasonably to deter or harass creditors in their bona fide efforts to realize upon their securities, good faith does not exist. But if it is apparent that the purpose is not to delay or defeat creditors but rather to put an end to long delays, administrative expenses, statutory periods of redemption and unreasonable obstruction by minorities, incident too frequently, we are sorry to observe, to mortgage foreclosure, and to invoke the operation of the act in the spirit indicated by Congress in the legislation, namely, to attempt to effect a speedy efficient reorganization, upon a feasible basis, supported by more than two-thirds of all the creditors, good faith cannot be denied."

The petition in Loeb Apartments was perceived by this court as an effort to enable the majority of the creditors to effectuate a reorganization plan which a minority had succeeded in obstructing in lengthy proceedings in the state court. Unlike the petition in that case, the one before us seeks to delay and defeat the bona fide effort of the sole creditor (other than the tax collector) to realize upon its security and would impose on that creditor a long-range plan of delayed payments. This is not the kind of case which Loeb Apartments indicates is appropriate for relief under Chapter X. We therefore need not decide how much is left of Loeb Apartments in view of the enactment since that decision of Chapter XII, 11 U.S.C. § 801, et seq., which permits real property arrangements for individuals.*fn2 See 6 Collier on Bankruptcy, supra, para. 6.07 at 1051-1053.

Northland argues that, notwithstanding the differences between this case and Loeb Apartments, that case supports its position, because, like the debtor in that case, it is merely seeking one of the advantages Chapter X was intended to offer - protection of a viable business enterprise from unnecessary liquidation. The presence of such a purpose is not enough in itself to satisfy the requirement of good faith. We are satisfied that Congress did not intend that chapter to be used by individual debtors to avoid foreclosure in a case such as this, where there has been no showing of any need which a reorganization under Chapter X is ordinarily designed to serve. See General Stores Corp. v. Shlensky, 350 U.S. 462, 100 L. Ed. 550, 76 S. Ct. 516 (1956). As the bankruptcy judge said:

"No investigation of management or readjustment of financial structure is needed or contemplated. There has been no suggestion of any fresh contribution other than the continued utilization of the services of Bernstein and Cunningham and their organization, and the funds needed to make the premises suitable for use by the new tenants. The only reorganization plan mentioned is one of pure delay."

Moreover, even if this case otherwise satisfied the requirements of good faith, the debtor's position would be untenable, because the petition falls within § 146(3) of the Act, 11 U.S.C. § 546, which provides that "a petition shall be deemed not to be filed in good faith if - . . . (3) it is unreasonable to expect that a plan of reorganization can be effected; . . . ." Unlike the debtor in Loeb Apartments, in which the requisite percentage of creditors had already approved a reorganization plan when the petition was filed, the debtor here must rely on the "cram down" provisions of Chapter X, §§ 179 and 216(7), 11 U.S.C. §§ 579, 616(7), to impose the plan on Penn Mutual, which has steadfastly asserted its opposition to any plan other than immediate payment in full. Northland concedes that it could not take advantage of these provisions if the bankruptcy judge was correct in finding that the corporation was insolvent. See § 179, 11 U.S.C. § 579. We cannot say that that finding was clearly erroneous. Northland argues that Ace Bernstein's ...

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