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In re South Beach Securities

July 24, 2009


The opinion of the court was delivered by: Judge Joan H. Lefkow

Bankruptcy Case No. 05 B 16679


This case arises from two appeals from an order dated November 1, 2007 of the bankruptcy court denying confirmation of a plan of reorganization under chapter 11 of the Bankruptcy Code, 11 U.S.C. §§ 1101 et seq., and the subsequent judgment of dismissal entered January 2, 2008 (B. Dkt. No. 173).*fn1 South Beach Securities, Inc ("South Beach"), and its sole creditor, Scattered, Inc. ("Scattered"), seek reversal and remand for entry of an order confirming the plan. The United States Trustee is the sole responding party.

The following summary of the underlying facts, which appear to be undisputed, is based on the parties' briefs (Dkt. Nos. 14, 28) and the November 1, 2007 memorandum opinion of the Honorable A. Benjamin Goldgar, the bankruptcy judge assigned to this case (Dkt. 130) (hereinafter, "Goldgar Op.").

I. Facts

South Beach was once registered as a securities broker/dealer with the SEC, but at all relevant times it had no employees and no assets of alleged value other than $3.2 million in net operating losses ("NOLs"). There was, indeed, scant evidence that South Beach had ever actually done business, and the provenance of the NOLs "was not explained." Goldgar Op. at 4. South Beach's sole officer/director is named William Johnson, who receives no compensation and has had no known participation in the affairs of South Beach.

South Beach is wholly owned by NOLA, LLC. NOLA has never had any business operations. NOLA's members are Leon Greenblatt II, James Nichols, and Robert Jahelka. NOLA's only asset is the stock of South Beach. Teletech Systems, Inc. ("Teletech"), manages NOLA. Teletech's president at relevant times was Leon Greenblatt III ("Greenblatt"). Teletech receives no compensation for managing NOLA and Greenblatt receives no compensation from Teletech.

In January, 2001, Greenblatt arranged with Loop Corporation for South Beach to borrow $2.1 million to be used as capital and repaid over 5 years.*fn2 Greenblatt testified at the confirmation hearing that he "participated in the funding of" the loan. Goldgar Op. at 5. South Beach thereafter lent to NOLA $3.2 million for the purpose of purchasing the stock of Heath Risk Management, Inc. ("HRM"). In December, 2002, Loop assigned its ($2.1 million) interest in the South Beach loan agreement to Scattered in exchange for $100,000. This made Scattered a creditor of South Beach. Scattered's officers and directors are Greenblatt, Jahelka and Nichols.

South Beach, Scattered, NOLA, and Teletech all use the address of 330 South Wells Street, Chicago Illinois.

On April 27, 2005, South Beach and NOLA filed voluntary petitions under chapter 11 of the Bankruptcy Code. South Beach's schedules reflected no assets of any kind except the HRM stock with a value of $0.*fn3 They disclosed Scattered as the only creditor, with an unsecured claim of $3.2 million. Greenblatt signed the filed documents on behalf of South Beach.

The bankruptcy court dismissed both petitions as having been filed in bad faith, contrary to § 1112(b). South Beach appealed. The district court reversed the dismissal and remanded for further proceedings (B. Dkt. No. 52). The case was reopened and South Beach filed a plan of reorganization on September 21, 2006 (B. Dkt. No. 83). The plan established two classes of creditors. Class 1 was "general unsecured claims." It had one member, Scattered. Class 2 was "holders of [equity] interests" but identified no members. The bankruptcy court, however, determined that NOLA, as holder of all of the stock of South Beach, was a class 2 member. The plan stated that both classes were impaired.

Under the plan, the interests of Class 2 creditors were to be cancelled. South Beach would then issue 1,000 shares of common stock, and the class 1 creditor was to receive these shares in satisfaction of its $3.2 million claim. South Beach would then be discharged. "Put simply," the bankruptcy court stated, "in exchange for relinquishing its large but worthless claim against South Beach, Scattered will become the new owner of South Beach, replacing NOLA." Goldgar Op. at 7. In a memorandum filed August 3, 2005, South Beach and NOLA represented, in reference to the initially proposed plan,

The value of South Beach's NOLs can only be preserved for the benefit of creditors through a plan of reorganization. Outside of bankruptcy, NOLs are often lost when a company is sold, because the sale results in a change of ownership of more than 50%. The Internal Revenue Code has an exception, however, which allows the preservation of NOLs where ownership is transferred to creditors under a chapter 11 plan. Therefore, the only means by which Scattered can recover the NOLs is through the plan. The draft plan preserves the benefit of the NOLs for the Reorganized South Beach and its equity holder.

Consol. Mem. of NOLA and South Beach Regarding the Good Faith Filing Requirement at 4 (internal citations omitted) ( B. Dkt. No. 30). That document made no reference to threatened litigation. The disclosure statement recited that "the sole asset of any value of the Debtor was a net operating loss ("NOL") carryovers [sic] for U.S. federal income tax purposes, pursuant to section 382 of the Internal Revenue Code." Disclosure Statement at 1 (B. Dkt. No. 89).

The disclosure statement represented without explanation that South Beach waived its $3.2 million claim against NOLA for purposes of this bankruptcy case.

Scattered voted in favor of the plan. The Trustee objected to confirmation arguing that the plan could not be confirmed because no non-insider impaired class had voted in favor of the plan as required by § 1129(a)(10) and because its principal purpose was to avoid taxes in violation of § 1129(d).

The bankruptcy court held an evidentiary hearing. At the hearing, Greenblatt denied that Scattered, of which he was president, was an insider of South Beach, with which he had no formal relationship. He testified that Scattered would make a sufficient capital contribution to South Beach in order for South Beach to have income sufficient for the net operating losses to be offset against. He denied, however, that the ...

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