The following is a case update written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, located in Los Angeles, California, analyzing a recent decision of interest:
Colorado Bankruptcy Court grants motion to convert case from Chapter 11 to Chapter 7, concluding that debtor’s bad faith filing did not justify dismissal of the case despite debtor’s possible ownership interests in cannabis-related entities, as conversion to Chapter 7 was in the best interest of creditors. See In re Roberts, 644 B.R. 220 (Bankr. D. Colorado 2022).
To read the full opinion, click here.
Debtor Michael Roberts Sr. (“Debtor”) owns assets worth approximately $53 million. Along with creditors Timothy Flaherty and Timothy Kneen, Debtor is a member of PdC, LLC (“PdC”), which purchased multiple real properties in Mexico through subsidiaries. Debtor allegedly defrauded Flaherty, Kneen and PdC (collectively, the “PdC Creditors”) out of their ownership of certain Mexican properties, resulting in litigation in the Denver District State Court. After multiple evidentiary hearings conducted by three different judges, Debtor was held in civil contempt, had a judgment entered against him for breach of fiduciary duty to PdC and his co-members, jailed for failing to comply with multiple court orders, and defaulted on various claims and counterclaims alleged against him. When the state court scheduled a damages hearing, which had already been continued twice, Debtor filed for bankruptcy under subchapter V of Chapter 11. As a result of the bankruptcy, the damages hearing was continued, and Debtor was released from jail despite the contempt order. Debtor proposed a Chapter 11 plan of reorganization, which had not been set for a vote or hearing by the time the motion to convert was heard.
The bankruptcy court granted relief from stay to allow the damages hearing to proceed. The state court ultimately awarded the PdC Creditors over $21,000,000 in damages against the Debtor, including $5,500,000 in exemplary damages. The state court issued a 32-page ruling detailing Debtor’s “bad conduct,” including disobeying court orders, fraud, lying under oath, and preventing Flaherty and Kneen from selling multiple properties for their maximum market value. The court concluded that Debtor’s actions resulted in PdC suffering total losses as to certain Mexican properties.
The PdC Creditors filed a motion to convert the case to Chapter 7, arguing, among other, that Debtor filed the case in bad faith to delay the damages hearing, get out of jail, and to prevent the PdC creditors from liquidating the state court judgment against Debtor. They further argued that the Chapter 11 plan was proposed in bad faith, as it contradicted the state court’s judgment, suggesting that Debtor sought two bites at the proverbial apple. The creditors argued that because of his alleged bad faith actions Debtor was not eligible to remain a debtor in Subchapter V.
Debtor disputed these allegations, arguing that his case was filed in good faith, including his efforts to seek protection of the bankruptcy court in response to an impending judgment in the state court. He asked the bankruptcy court to focus on his alleged “good faith” post-petition conduct as a debtor-in-possession. Debtor argued that he satisfied the test in 11 U.S.C. section 1112(b), justifying denial of the motion to convert. However, if the court were inclined to convert, Debtor argued that the case should be dismissed because his assets included ownership interests in entities that were involved with cannabis, which would improperly become assets of a Chapter 7 estate upon conversion.
The bankruptcy court granted the motion to convert to a case under Chapter 7 and denied Debtor’s request for dismissal.
Bankruptcy Judge Joseph G. Rosania, Jr. analyzed the motion under Section 1112(b)(1), which requires conversion or dismissal of a case, “whichever is in the best interest of creditors and the estate, for cause. . . .” According to this section, a dismissal or conversion hinges on a two-step analysis. The court first determines whether “cause” exists to dismiss or convert. If it does, the court must decide whether either remedy would be in the best interest of creditors and the estate. See 11 U.S.C. § 1112(b)(1).
Section 1112(b)(4) provides a non-exclusive list of 16 factors that support a finding of “cause” for dismissal or conversion. While “bad faith” is not one of the factors, courts agree that bankruptcy cases must be filed in good faith. Whether a case was filed in bad faith is determined on a case-by-case basis. Ultimately, the moving party has the burden of proving “cause” for conversion or dismissal by a preponderance of the evidence. Once cause is established, the burden shifts to an opposing party to prove that the requested remedy is not in the best interest of creditors and the estate. Courts are afforded a “broad discretion” under Section 1112(b).
The bankruptcy court concluded that the facts here presented a “textbook example” of a bad faith bankruptcy filing. The Court relied on Debtor’s fraud, the fact that his only unsecured debt was related to his fraudulent conduct, the state court’s issuance of an attachment order that the bankruptcy court equated to a foreclosure action, the timing of the bankruptcy filing, the fact that Debtor was an individual investor with no ”ongoing” business or employees, and doubts as to whether Debtor’s proposed plan was feasible or confirmable. Based on these facts, among others, the court concluded that Debtor filed this bankruptcy case in bad faith.
However, bad faith is not the end of the analysis and did not necessarily require dismissal. Rather, the Court could convert the case to Chapter 7 if it determined that it would be in the best interest of the creditors and estate.
While Debtor testified that he owned interests in two “cannabis-related” businesses, his testimony was vague and inconclusive as to the nature of each entity’s business, Debtor’s ownership interests in the entities, and even the values of Debtor’s interests in the companies. The Court therefore held that it lacked sufficient information to conclude that Debtor owned sufficient interests in cannabis-related businesses to justify denial of the request for conversion.
The Court noted that the U.S. Trustee’s Office did not object to conversion, and even quoted the Ninth Circuit Bankruptcy Appellate Panel,
the mere presence of marijuana near a bankruptcy case does not automatically prohibit a debtor from bankruptcy relief . . . Instead, a bankruptcy court must be explicit in articulating its legal and factual bases for dismissal in cases involving marijuana.
See In re Burton, 610 B.R. 633, 637-38 (Bankr. App. 9th Cir. 2020).
The Court concluded that Debtor offered inconclusive evidence regarding the cannabis-related entities, such that it could not explicitly articulate a factual basis for dismissal based on the alleged cannabis-related assets. The Court did not foreclose a future dismissal of this case if the record were to better identify the nature of the cannabis assets.
Like most decisions, context is key to understanding this ruling. Debtor defrauded his business associates, placed foreign assets out of the reach of a U.S.-based court, refused to comply with injunctions issued by the Colorado state court, and was willing to go to jail pursuant to a contempt finding rather than comply with the state court’s orders. Thus, when Debtor filed for bankruptcy to delay the state court hearing on damages and avoid the consequences of his contemptuous conduct, the bankruptcy court was not sympathetic to assertions that Debtor held ownership interests in cannabis-related entities. This was especially true where Debtor served as a debtor-in-possession for seven-and-a-half months with full knowledge of these assets. Under these circumstances, and no opposition by the U.S. Trustee, the Court concluded that a Chapter 7 trustee was in the best interest of the creditors and Debtor’s estate.
This ruling may further suggest that some bankruptcy courts are reluctant to dismiss cases simply because they tangentially involve cannabis assets, especially if the assets are not central to the debtor’s business operations. If a court concludes that conversion would serve a debtor’s creditors and his estate better than dismissal, it has broad discretion under Section 1112(b) to refuse dismissal of a case involving cannabis assets.
This review was written by Uzzi O. Raanan, a partner at Danning, Gill, Israel & Krasnoff, LLP, located in Los Angeles, California, who is a member of the ad hoc group and the representative from the Business Law Section (BLS) to the CLA’s Board of Representatives. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.