MARTIN, JR., District Judge
This is an appeal from the bankruptcy court's denial of appellant Faflich Associate's ("Faflich's") motion to convert respondent Court Living Corporation's ("Court Living's") case from Chapter 11 to Chapter 7 pursuant to 11 U.S.C. § 1112(b).
Background
The debtor is Court Living, a sole asset entity that owns 58 and 60 Court Street ("the premises"). Debtor purchased the premises in 1984 from appellant Faflich. As part of the sale, debtor issued a 99-year lease to Faflich for the three stores on the first floor of the premises and part of the cellar, for $100 a year rent. The lease contains a provision which states that Faflich may pay taxes, water charges or other liens that the debtor fails to pay and that Faflich will, by virtue of such payment, have a lien against the building upon which it can foreclose. Faflich, after having paid more than $50,000 in taxes and charges, filed a foreclosure action in state court alleging that it held four first priority tax liens against the property.
An entity related to the debtor acquired the adjacent property, 56 Court Street. Both the adjacent property and the property at issue here have retail store spaces on the ground floor, but have gutted, vacant, and uninhabitable upper floors. Debtor claims that renovations began in 1987 but halted in 1988 due to the down-turn in the real estate market as well as disputes with the mortgage holder.
The debtor alleges that Faflich was responsible, under the lease, for a portion of these taxes and notes that, although Faflich claims that it paid for an elevator inspection, the premises do not have an elevator.
When debtor's response to Faflich's motion for summary judgment in the state court foreclosure action was due, Court Living filed a Chapter 11 petition, thus staying the foreclosure action under the Bankruptcy Code's automatic stay provision. The debtor, which has no employees except its principals, listed $100 in total assets and various unsecured creditors in its schedules.
There are three mortgages on the premises: Cortland Funding Corporation — which joins in the debtor's opposition to Faflich's motion — holds a first mortgage in the principal amount of $3,136,000, and a second mortgage in the principal amount of $2,863,900. Fifty-Six Properties holds a third mortgage, in the principal amount of $950,000. Each of the mortgages contains a non-disturbance clause pursuant to which each mortgagee promises that, should it come into possession of the premises, it will not disturb Faflich's use of the premises under the lease.
The City of New York holds a tax lien against the premises that is more than $100,000 and that continues to grow as the debtor continues to fail to pay its taxes.
After filing for bankruptcy, debtor — joined by mortgage holder Cortland Funding Corporation ("Cortland") — filed an action in bankruptcy court in which they seek to have the Faflich lease "properly characterized." The debtor and Cortland argue that the 99-year "lease" with Faflich is not a lease, but rather is a participation interest in the premises. They thus contend that debtor is entitled to a portion of the rents that Faflich has collected on subleases for the stores on the premises, and that Faflich is responsible for a share of the premise's real estate taxes. The debtor claims that it cannot file a reorganization plan that properly classifies Faflich's claim against the premises until the bankruptcy court has determined the nature of Faflich's claim.
The corporation that owns the property adjacent to the debtor's property (the "related debtor"), described in note 1, filed a chapter 11 petition on the same day as the debtor. The related debtor has secured funding in the amount of $780,000 to renovate the adjacent property, and began construction on October 26, 1995. The debtor claims that renovation of the premises at issue here depends upon renovation of the adjacent property. This is because New York City regulations require two means of egress from the property at issue here. According to the debtor, it will obtain an easement from the related debtor for such a second entrance upon completion of renovation of that property.
In February 1995, Faflich moved in the bankruptcy court to dismiss the debtor's bankruptcy petition or, alternatively, to lift the automatic stay to allow it to proceed with the foreclosure action. After holding an evidentiary hearing, the bankruptcy court denied Faflich's motion. In October 1995, Faflich filed the motion to convert that is the subject of this appeal. The bankruptcy court also denied Faflich's motion to convert, noting that it was basically a renewal of the motion to dismiss and declining to hold another evidentiary hearing.
In the course of discovery leading up to that motion, Faflich discovered that the Secretary of State had dissolved Court Living in June of 1993 for failure to file corporate franchise tax returns. The bankruptcy court gave Court Living a fixed time within which to reinstate, and it met this deadline, reinstating on September 22, 1995.
Motions to convert and dismiss a bankruptcy petition are governed by the same standard, set forth in 11 U.S.C. § 1112(b), discussed below.
The bankruptcy court set forth three general bases in denying Faflich's motion to convert. First, she accepted the debtor's argument that it was more logical and economically feasible to renovate the adjacent property before commencing renovation of the premises at issue here. The court noted that Faflich offered nothing to disprove the debtor's earlier testimony, that construction on the adjacent property was underway and that construction on the debtor's property could not begin until the adjacent property construction was completed. The bankruptcy court's second basis for denial was her concern that Faflich was simply moving to convert so that it could "grab the entire property for nothing." She noted that a Chapter 7 trustee, should the case be converted, would simply abandon the property as worthless. Third, the bankruptcy court found that Faflich was not being harmed by the debtor's failure to repay the $50,000 in taxes at that time, as there was enough equity in the property to cover the taxes. The court also pointed out that Faflich continued to earn money from its rental of the retail store space.
The court did not issue a written decision. The denial is contained in a transcript of the November 9, 1995 hearing on the motion to convert, which the parties have provided to the Court. This Court relied on the bankruptcy court's factual determinations from an evidentiary hearing held on May 12 and 15, 1995.
Discussion
Section 1112 of the Bankruptcy Code governs "[c]onversion or dismissal" of a bankruptcy petition. That section states, in relevant part:
(b) . . . on request of a party in interest . . ., and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title or may dismiss a case under this chapter, whichever is in the best interest of creditors and the estate, for cause, including —
(1) continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation;
(2) inability to effectuate a plan;
(3) unreasonable delay by the debtor that is prejudicial to creditors;
(4) failure to propose a plan under section 1121 of this title within any time fixed by the court.
11 U.S.C. § 1112(b).
Faflich, as the moving party, bears the burden of proving cause for conversion by a preponderance of the evidence. Matter of Woodbrook Associates, 19 F.3d 312, 317 (7th Cir. 1994); In re Lizerac Realty Corp., 188 B.R. 499, 503 (Bankr.S.D.N.Y. 1995). "Under Federal Rule of Bankruptcy Procedure 8013, this court reviews the Bankruptcy Court's findings of fact under the clearly erroneous standard and reviews its conclusions of law de novo." Fairchild Aircraft Inc. v. Jet Express, Inc., 158 B.R. 578, 580 (S.D.N.Y. 1993); see also In re Kanterman, 88 B.R. 26 (S.D.N.Y. 1988).
Faflich claims that, because there were no facts presented at the November 9, 1995 hearing on the motion to convert, there could be no factual determinations. Rather, according to Faflich, the court made legal conclusions subject to a de novo standard of review. However, on November 9 the bankruptcy court specifically relied on the evidentiary hearing held on May 12 and 15, 1995 in connection with Faflich's motion to dismiss. She noted that Faflich failed to submit a factual affidavit that would cause her to question the debtor's representations about the construction schedule on the adjacent property. Thus, the bankruptcy court made both factual determinations and legal conclusions.
Faflich claims that the bankruptcy court erred by denying the motion on the equities, despite the alleged prominence of several § 1112(b) "causes" in the debtor's case. Faflich advances three arguments for conversion under § 1112(b): 1) the debtor's assets are being depleted even though the debtor has failed to effectuate a reasonable strategy for rehabilitation; 2) the debtor has yet to submit a reorganization plan despite — at the point the appeal was filed in May 1996 — having had Chapter 11 protection for over eight months, and this delay has been prejudicial to Faflich; and 3) the debtor is unable to effectuate such a plan. These three arguments go to § 1112(b)(1)-(4), which the Court will address in turn below.
As a preliminary matter, the Court notes that § 1112(b) is a non-exclusive list and thus the bankruptcy court may consider factors other than those listed in § 1112(b) in coming to a decision. See In re Reichert, 138 B.R. 522, 523 n. 1 (W.D.Mich. 1992). Here, the bankruptcy court's concern with the effect of conversion — that it would be tantamount to dismissal, and would allow Faflich to grab the property — is legitimate, as it takes into account both the equities of the situation, and the potential prejudice to other creditors.
I. Section 1112(b)(1): "continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation."
Section 1112(b)(1) requires both loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation. This subsection "is intended to preserve estate assets by preventing the debtor in possession from gambling on the enterprise at the creditors' expense when there is no hope of rehabilitation." In re Lizeric Realty Corp., 188 B.R. 499, 503 (Bankr.S.D.N.Y. 1995). "[T]he term `rehabilitate' means to put back in good condition; re-establish on a firm, sound basis." Id.
On the issue of likelihood of rehabilitation, Faflich argues that the debtor has had many months to commence renovation of the premises, and has failed even to secure funding. Faflich is correct that there are a number of cases, involving circumstances similar to this case, in which courts granted a motion to convert or dismiss. For example, in In re CCN Realty Corp., 23 B.R. 261 (Bankr.S.D.N.Y. 1982), the debtor's mortgagee (its major creditor), moved to dismiss under § 1112(b) on the same grounds as Faflich. The debtor was a real estate holding corporation with only one asset. The mortgagee started a foreclosure action, after which the debtor filed for chapter 11 protection. Id. at 262. The court granted the motion to dismiss the chapter 11 petition on the grounds that the debtor was in no financial condition to reorganize, had no income, had not paid its real estate taxes (which had accrued to $130,000 in arrears), had no firm commitment for additional capital, and had failed to file operating statements and to produce books and records on its financial condition. The debtor had been under chapter 11 protection for six months when the court granted the motion. Id. at 262-63.
The appeal now before the Court has two principal differences, as articulated by the bankruptcy court, from cases such as CCN. First, the debtor is related to the adjacent debtor, and has a renovation plan encompassing both properties which calls for renovation of the adjacent property first. For this reason, the bankruptcy court found that there was a reasonable likelihood of rehabilitation, and denied a for-cause conversion under § 1112(b)(1). Thus, unlike CCN, there is a plan for rehabilitation, although it is somewhat unusual in being linked to another debtor in another bankruptcy action. This fact makes this case more closely analogous to In re Nielsen, 6 B.R. 82 (N.D.Ala. 1980), in which the debtor's only asset was stock in a company that was itself undergoing reorganization. The court denied a motion to dismiss under § 1112(b)(1) and (2) on the grounds that, if the company in which the debtor had stock was successful at reorganizing, the debtor would have a valuable asset. Id. at 83. Second, the bankruptcy court found that conversion here would be tantamount to dismissal, and would allow Faflich to grab the entire property to satisfy the approximately $50,000 that it is owed.
In short, this is not a situation where the debtor is gambling on the enterprise at the creditors' expense when there is no hope of rehabilitation. The bankruptcy court's determination that there was a reasonable likelihood of rehabilitation was not clearly erroneous, and the denial of a § 1112(b)(1) conversion was proper.
II. Section 1112(b)(2), the "inability to effectuate a plan."
"[C]ourts will dismiss Chapter 11 cases under this section where the debtor lacks the ability to formulate a plan or carry one out." In re Lizerac, 188 B.R. at 503 (internal quotation omitted). Faflich's argument here is essentially that it will vote against any reorganization plan, and that the City of New York will also want to enforce its claims against the debtor.
Therefore, the only way the debtor will be able to effectuate a plan will be to use the Bankruptcy Code's "cram down" provision, 11 U.S.C. § 1129(b)(1), which would require the debtor to pay Faflich and the City what they are owed by the effective date of the plan. Faflich then claims that the only currently viable way for the debtor to obtain funds to pay Faflich and the City before an effective date would be to secure funding from Cortland. However, Cortland has apparently insisted that its funding for renovations of the premises is contingent upon Faflich subordinating its lien. Since Faflich will not agree to such subordination, the debtor effectively has no way to effectuate the plan.
The Lizerac court rejected a similar "cram-down" argument as premature, where the debtor had yet to propose a reorganization plan. Id. at 503-04; see also In re Hempstead Realty Associates, 38 B.R. 287, 290 (Bankr.S.D.N.Y. 1984) (rejecting creditor's argument that debtor could not confirm plan because creditor would not give approval, which was necessary for confirmation, on grounds that "no plan has been filed and . . . various possibilities might occur between now and any proposed confirmation," made dismissal premature).
Thus, conversion pursuant to § 1112(b)(2) would be inappropriate.
III. Section 1112(b)(3): "unreasonable delay by the debtor that is prejudicial to creditors," and Section 1112(b)(4): "failure to propose a plan . . . within any time fixed by the court." As the court noted in In re Hempstead Realty Associates, 38 B.R. 287 (Bankr.S.D.N.Y. 1984), "[u]nreasonable delays may justify a dismissal under Code § 1112(b)(3) if such delays are prejudicial to creditors."Id. at 289 (emphasis added). The delay here has caused some prejudice to Faflich, in that there has been a diminution in the estate due to the debtor's continued failure to pay New York City taxes, thus giving the City a priority lien in the amount of approximately $100,000. However, the bankruptcy court found that Faflich was not unduly prejudiced by the debtor's failure to pay these taxes, as there was still enough equity in the property to cover Faflich's claim. Furthermore, the bankruptcy court noted that Faflich continues to collect rents from the first floor stores. The bankruptcy court's determination that Faflich was not prejudiced by the delay, based on all of the circumstances of the case, was not clearly erroneous.
In addition, Faflich has failed to show that the bankruptcy court's finding that there was no unreasonable delay was clearly erroneous. "The `unreasonable delay' standard must be read in conjunction with section 1112(b)(2) which permits dismissal or conversion based upon inability to affectuate a plan and section 1112(b)(4) which permits conversion or dismissal based upon the failure to propose a plan." 5 Collier on Bankruptcy § 1112.03 at 1112-23 (15th ed. 1996). The debtor's inability to affectuate a plan is discussed above, in section II.
As noted above, the debtor has not yet filed a reorganization plan. It does not appear that the bankruptcy court has set any time within which the debtor must file such a plan. However, at the November 9, 1995 hearing the bankruptcy court stated that it had "chosen a course of direction for these cases." This entailed reinstatement of the debtor's corporate charter, which was accomplished, to be followed by retention of an attorney. The court noted at the hearing that the retention application was with the U.S. Trustee's office and that the court then expected to receive it.
The debtor claims that it cannot file a plan until the "lease characterization" action, described above, is decided. That action is now pending before the bankruptcy court, and the bankruptcy court may have taken this into account in declining, thus far, to impose a deadline by which the debtor must file a plan. While Faflich is correct that the debtor cannot unreasonably delay its filing of a reorganization plan, the bankruptcy court is best equipped to set a reasonable time within which the debtor must file. This Court declines to set such a deadline at this time.
Thus, the denial of conversion pursuant to § 1112(b)(3) and (4) was appropriate.
Conclusion
Accordingly, the bankruptcy court's denial of Faflich's motion to convert is affirmed.
SO ORDERED.