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Bankruptcy Court Grants NYC's Motion to Vacate Automatic Stay and Dismiss Case

Tuesday, September 20, 2011
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In re Inwood Heights Housing Development Fund Corp., Case No. 11-13322, 2011 BL 219634 (Bankr. S.D.N.Y. Aug. 25, 2011) The United States Bankruptcy Court for the Southern District of New York granted a motion filed by several New York City agencies seeking to vacate for "cause" the automatic stay in effect following a chapter 11 petition filed by a debtor-housing development corporation. At the same time, the bankruptcy court granted the city’s request to dismiss debtor’s chapter 11 case, declaring that it would enter a dismissal order after the city sold debtor’s apartment building at a foreclosure sale.

The Housing Development Fund Corporation

In 1992, Inwood Heights Housing Development Fund Corporation ("Inwood" or "Debtor") was incorporated in New York as a not-for-profit housing development corporation fund ("HDCF") for the purpose of operating low income housing in the Bronx under a program created by the New York City Department of Housing Preservation and Development ("HPD") and other agencies (collectively, "NYC"). NYC sold a Bronx residential building ("Property") to Inwood, in exchange for a $1 and a non-interest bearing note ("Note"), secured by an enforcement lien mortgage in the amount of $999,999 ("Mortgage"), the appraised value of the Property and deed ("Deed"), along with various project loan documents (collectively, "Agreements"). The Agreements specified that any additions to the HDCF’s board of directors ("Board") were subject to HPD approval. The Mortgage required Inwood to pay water, sewer charges and real estate taxes. The Deed indicated that Inwood accepted the Property subject to various covenants that "ran with the land." Specifically, the Deed prohibited the transfer or disposition of the Property for a thirty-two year term ("Restriction Period") without HPD’s approval and provided that the Property would revert back to HPD if Inwood was in default on any covenants. The Agreements contained use restrictions, requiring the Property to remain as low income housing and to be owned by a not-for-profit or government entity during the Restriction Period. Under the Agreements, the HDCF and Property sponsor agreed to pursue maximum collectible rents and establish reserves ("Reserves") from which the HDCF would fund repairs of the Property. Inwood failed to maintain the Reserves, requiring NYC to pay water and sewer bills, which resulted in additional liens on the Property.

The Bankruptcy Filing and Lift Stay Motion

Thereafter, on July 11, 2011 ("Petition Date"), Inwood filed a petition for chapter 11 bankruptcy protection, the same day that HPD was scheduled to foreclose on the Property. NYC filed a motion ("Motion") seeking to dismiss Debtor’s case for "cause" pursuant to 11 U.S.C. § 1112(b), or alternatively, to lift the automatic stay under 11 U.S.C. § 362(d) to permit NYC to proceed with a foreclosure sale of the Property. In the Motion, NYC argued that the bankruptcy petition was filed in bad faith because Debtor’s current Board was not approved by HPD, and therefore, not authorized to file for bankruptcy. Moreover, NYC argued that Debtor had no authority to transfer ownership of the Property or to modify the covenants and use restrictions encumbering the Property. Further, NYC alleged that Debtor lacked equity in the Property and therefore, dismissal or lifting the stay was warranted. At a hearing, the evidence established that for over six years, Debtor had failed to make required financial disclosures to HPD. Further, while the monthly rents from the Property were estimated to equal $18,000, Debtor monthly cash receipts were only $8,000 and Debtor testified that the current Board had not taken any legal action against non-paying tenants. NYC testified that its statutory liens for unpaid taxes, water and sewer charges totaled over $500,000 and Debtor owed HPD $999,999 pursuant to a state court foreclosure judgment ("Judgment"). The evidence revealed that Debtor’s former management team commingled funds, made unauthorized loans to affiliates, mismanaged the Property and falsified records. In its opinion, the bankruptcy court considered whether "cause" existed to grant NYC relief from the stay or to dismiss the case. Applying the same standard governing dismissal under 11 U.S.C. § 1112(b)(4)(A) to the context of stay relief under 11 U.S.C. § 362(d)(1), the bankruptcy court found a continuing diminution to Debtor’s estate and concluded that because the enforceable restrictive covenants essentially made the Property unmarketable, Debtor had no reasonable likelihood of rehabilitation and could not confirm a plan. Notably, while briefly examining the Board’s alleged lack of authority and bad faith in filing the bankruptcy petition, the bankruptcy court based its decision to lift the stay and dismiss Debtor’s case on the Bankruptcy Code’s statutory language governing dismissal and stay relief. The bankruptcy court’s process reflects an efficient, practical approach to granting such relief when the facts satisfy the applicable statutory standards, thereby obviating the need to conduct a time-consuming and costly full scale inquiry of other factual issues.

Relief from the Stay and Dismissal were Warranted

Beginning its analysis, the bankruptcy court explained that under § 362(d)(1), a court shall grant relief from the automatic stay for "cause," including but not limited to the lack of adequate protection of an interest in property. The bankruptcy court instructed that under § 1112(b), a court may dismiss or convert a chapter 11 case for "cause," if it is in the best interests of the estate and creditors. Next, examining whether stay relief and dismissal were warranted, the bankruptcy court noted that under §1112(b)(4)(A), cause exists for dismissal when there is a continuing loss to or diminution of the estate and no reasonable likelihood of rehabilitation. Noting that lifting the stay and dismissing the case would achieve the same result by permitting NYC to sell the Property at a foreclosure sale, the bankruptcy court applied § 1112(b)’s standard to the context of stay relief under § 362(d)(1). In doing so, the bankruptcy court found a continuing diminution of Debtor’s estate, noting that Debtor had a shortfall in monthly rent revenues, had taken no action to collect rent arrearages and lacked sufficient funds to cover daily operations. Further, the bankruptcy court declared that Debtor’s attempts to rehabilitate would be futile based on the enforceable restrictive covenants that prevented Debtor from disposing of the Property without HPD’s approval and required the Property to be used only for low income housing. See In re 523 East Fifth Street Housing Dev’t Fund Corp., 79 B.R. 568, 574-75 (Bankr. S.D.N.Y. 1987) (denying 11 U.S.C. § 363(f) sale of debtor’s property free and clear of liens based on restrictive covenants that ran with the land). Additionally, the bankruptcy court pointed out that Debtor could not likely confirm a plan. Assuming the accuracy of Debtor’s $1.3 million valuation of the Property, the bankruptcy court reviewed that NYC’s liens and Judgment alone, totaling over $1.5 million, exceeded that value. Further, noting that Debtor failed to show that it could obtain financing to fund a plan, the bankruptcy court remarked that even if Debtor obtained financing, its monthly rental income could not service such a sizeable loan. The bankruptcy court added that any loan would also be subject to approval from HPD, which had instead determined to conduct a foreclosure sale and credit bid or transfer the Property to another HDCF. As further support for its decision to lift the stay, the bankruptcy court found that NYC was not adequately protected under 11 U.S.C. § 361, based on Debtor’s failure to grant NYC the "indubitable equivalent" of its interests.

Lack of Authority to File Petition and Bad Faith

Finally, the bankruptcy court considered NYC’s position that because HPD never authorized the members of Debtor’s current Board, it lacked the authority to file the bankruptcy petition and did so in bad faith, in an attempt to stall the foreclosure of the Property. Notably, the bankruptcy court determined to lift the stay and dismiss the case without resolving the issue of the Board’s purported lack of authority. Similarly, turning to NYC’s allegation of bad faith, the bankruptcy court reviewed that a bankruptcy petition will be dismissed if objective futility of the reorganization process and subjective bad faith in filing the petition are found. In re Kingston Square Assocs., 214 B.R. 713, 725 (Bankr. S.D.N.Y. 1997). While declaring that the case was objectively futile based on Debtor’s unlikelihood of rehabilitation, the bankruptcy court declined to resolve the complex factual issue of subjective bad faith, holding that the relief requested was warranted, regardless of whether the filing was made in bad faith.

Bankruptcy Court Grants Motion

In sum, the bankruptcy court granted the Motion, lifting the stay and ordering the dismissal of the case. Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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