In re Village Oaks Senior Care LLC

The following is a case summary written by Gary B. Rudolph, a director at Fennemore LLP’s San Diego office, analyzing In re Village Oaks Senior Care LLC, 664 B.R. 170 (Bankr. ED CA 2024) a recent decision of interest.

Summary

In In Re Village Oaks Senior Care LLC, 664 B.R. 170 (E.D. CA 2024), the trial court sustained the creditor’s objection to the Debtors’ eligibility as Subchapter V debtors and de-designated them as chapter 11 cases, after finding that the objecting creditor had not forfeited or waived her ability to challenge the debtors’ eligibility.

To read the full decision, click here.

Facts

This case involved three related debtors– Village Oaks Senior Care, LLC, El Dorado Senior Care, LLC and Benjamin L. Foulk (“Dr. Foulk”). Dr. Foulk was the 100% owner of Village Oaks and El Dorado. Gina MacDonald (“MacDonald” or “Creditor”) was the former spouse of Dr. Foulk.

Dr. Foulk and Village Oaks were the borrowers on a $3,285,000 loan from First-Citizens Bank; El Dorado was a guarantor on the loan. In Dr. Foulk’s Schedule D, he listed a secured debt to First-Citizens in the amount of $3,250,000; yet in Village Oak’s Schedule D, it listed the liability to First-Citizens as “unknown” and El Dorado omitted the liability from its schedules all together. 

MacDonald filed a late motion objecting to the Debtors’ eligibility under Subchapter V, arguing that the debtors were affiliates under 11 U.S.C. section 1182. She also argued that based on Dr. Foulk’s scrupulous litigation and discovery tactics in their prepetition divorce proceeding, all three of the Debtors lacked the capacity to serve as fiduciaries of their respective estates, invoking section 1185.

Since Dr. Foulk was the individual signing the schedules, under oath, for Village Oaks and El Dorado, the bankruptcy court determined that those schedules were purposely manipulated to ensure that all three debtors were under the $7,500,000 subchapter V cap, which existed at the time the bankruptcies were filed. At oral argument counsel for the debtors did concede that if aggregated, the debts of the debtors exceeded the $7,500,000 statutory cap.

That left the court with two issues to resolve in determining Subchapter V eligibility. The first issue was whether MacDonald waived or forfeited her challenge to the Subchapter V eligibility, and the second issue was whether Village Oaks and El Dorado were affiliated debtors.

As to the first issue, the court believed the parties were confusing “forfeiture” and “waiver.” “Forfeiture,” the court explained, is the failure to timely assert a right, whereas “waiver” ordinarily means relinquishment or abandonment of a known right or privilege. The court ultimately found that MacDonald did not forfeit or waive her rights to object to the Subchapter V elections in each of the cases. 

As to the eligibility issue, the court held that pursuant to sections 1182(1)(A) and 101(2), Dr. Foulk’s 100% ownership and control of Village Oaks and El Dorado, the debtor entities were horizontally affiliated debtors. The fact that the debtors agreed that their aggregated debts exceeded the $7,500,000 Subchapter V cap, “goes a long way to explain why Village Oaks would schedule the amount of its debt to First-Citizens as ‘unknown’ and why El Dorado would omit its guarantor liability on that debt from its Schedules.”

The court went on to find that “it is apparent that the debtors knew or anticipated that the debtor entities may be ineligible to be subchapter V debtors.  In an effort to manufacture subchapter v eligibility, or to at least make it more likely, the debtors manipulated debt in the Village Oaks and El Dorado Schedules to bring aggregated debts below $7,500,000.”

Upon review of all the evidence, the court sustained MacDonald’s objections to the Debtors’ Subchapter V elections, de-designated each debtor as a Subchapter V case and the Subchapter V trustees were discharged.

The issue of removal of the debtors-in-possession as to each estate was continued to another date for further consideration through the court’s issuance of an Order to Show Cause why the debtors should not be removed from possession.

Reasoning

The court discussed how an objection to eligibility is waived—either by stipulation or by objection when presented “before the parties have expended much time, effort, or money on the case.”

The court recognized that MacDonald raised the eligibility issue in her initial appearances in each case and actively appeared and objected or responded to nearly every motion, application or request by the debtors, over the course of the three months following the filing. This work resulted in countless hours of attorney preparation and travel time, at great expense to the parties, as well as significant investment by the court of its own judicial resources. MacDonald’s extensive and substantive participation also altered the trajectory of the bankruptcy cases. However, the court also acknowledged that her conduct could have been considered a waiver of any objection to the debtors’ eligibility. Ultimately, the court held that waiver is an equitable doctrine and should not be invoked if it would create an inequitable result, as would be the case here, where the debtors manipulated their schedules to fabricate eligibility, when it otherwise did not exist.

Applying the waiver doctrine in this case would serve to encourage or reward the creation of false schedules to achieve Subchapter V eligibility. It would also allow the debtors to proceed as Subchapter V debtors, when they knew that they were not, or may not, be eligible. In this instance, the court declined to apply the waiver doctrine because it would bring about inequitable results.

.Based on the debtors’ purposeful manipulation of the schedules in each of their cases, the court set a separate hearing through the OSC, to discuss the appointment of a chapter 11 trustee in each of the cases, to ensure confidence and trustworthiness of the debtors and their management.

Author’s Commentary

This case is a shining example of what not to do. The facts unequivocally supported the decision of the court.  But, what about the debtors’ lawyer’s judgment and decision to allow such manipulation in schedules? The court was silent about their possible role in preparing schedules that were patently false.

These materials were prepared by ILC member Gary B. Rudolph, a Director with Fennemore LLP’s San Diego office, with editorial contributions from ILC member Summer Shaw, shareholder at Shaw & Hanover and the Hon. Meredith Jury (ret.).