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Sapphire Development, LLC v. McKay

United States District Court, D. Connecticut

February 1, 2016

Sapphire Development, LLC & Hudson City Savings Bank, Appellants,
v.
Robert J. McKay, Appellee.

OPINION AND ORDER

Michael P. Shea, U.S.D.J.

One business day before the start of trial in a state court lawsuit that sought to void the transfer to it of real estate, Sapphire Development, LLC ("Sapphire"), filed for bankruptcy under Chapter 11 of the Bankruptcy Code, effectively staying the state court action. Crying foul, the plaintiff in the state court action, Robert McKay, moved to dismiss the bankruptcy for "cause" under 11 U.S.C. § 1112(b)(1), arguing that it was filed in bad faith. After holding evidentiary hearings, the bankruptcy court agreed, and dismissed the case. Sapphire and Hudson City Savings Bank (“Hudson City”), a secured creditor, appeal the dismissal to this Court.[1] Because the findings of fact underlying the bankruptcy court's dismissal were not clearly erroneous and support the conclusion that there was "cause" to dismiss, I affirm.

Bankruptcy is an equitable remedy. When it is invoked to accomplish ends inconsistent with its equitable purposes, the bankruptcy court must dismiss the proceeding. Sapphire had no need to file for bankruptcy to reorganize or secure a "fresh start" as a business because it conducted no business. As the bankruptcy court found, it has had no employees for almost a decade, has failed to pay taxes on the property to which it has title, has received income only from related entities, and has done nothing of significance in recent years other than hold the property on which its principal resides. Nor was there a material need to protect creditors from a disorderly dismemberment of the debtor's assets. As the bankruptcy court also found, Sapphire has only one asset (the real estate on which its principal has lived for thirty years), none of the secured creditors was threatening to foreclose on that asset, and the claims of the unsecured creditors were de minimis.

Sapphire and Hudson City have failed to show that any of the bankruptcy court’s findings was clearly erroneous, which leaves only one explanation for Sapphire's bankruptcy filing: a trial in the State Court Action was about to begin in which the plaintiff sought a finding that Sapphire's principal, rather than Sapphire itself, actually owned the real estate. And despite its stated intention to "reorganize" by subdividing the property, Sapphire did not, after filing under Chapter 11, file a subdivision plan with the Town Planning and Zoning Commission. Nor did it present evidence the bankruptcy court found credible that subdividing the property would enhance its value. In short, the bankruptcy court's dismissal for “cause” was supported by evidence that Sapphire's bankruptcy filing was a tactical litigation maneuver that would further no purpose of the bankruptcy laws. Further, Sapphire's argument that dismissal will prejudice creditors does not withstand scrutiny, because the only secured creditor that has a stake in maintaining the bankruptcy will have the same opportunity to contest the fraudulent transfer claims in state court that it would have in bankruptcy court. The bankruptcy court’s decision is therefore AFFIRMED.

This opinion supersedes the short-form order that was issued on January 25, 2016.

Background

Stuart Longman is the trustee of the Gayla Longman Family Irrevocable Trust (the “Trust”), which is the sole owner of Sapphire. Longman is also the operating manager of Sapphire; Gayla Longman is his wife. Sapphire, a limited liability company formed in 2000, owns - as its sole asset - a 25-acre property in Ridgefield, Connecticut (the “Property”), at which the Longmans have resided for over thirty years. Longman purchased the Property in 1985, and the Property has since been transferred between Sapphire, Longman, Longman’s wife, and several entities controlled by Longman. During this period, Hudson City, J.P. Morgan Chase Bank, and the Savings Bank of Danbury lent money to Sapphire and took mortgages on the Property.

In 1996, a New York state court awarded Robert McKay a $3.96 million judgment against Longman resulting from a finding of fraud. During the same year, McKay filed two certificates of foreign judgment against Longman in Connecticut Superior Court. In 2010, McKay filed suit in Connecticut Superior Court against Longman, Sapphire, several other entities controlled by Longman, Hudson City, and the Savings Bank of Danbury.[2] McKay v. Longman, et al., FST-CV-10-6007056-S (“State Court Action”). In the State Court Action, McKay seeks a constructive trust on the Property, a finding that Longman fraudulently transferred the Property to Sapphire, and a finding that Sapphire’s corporate veil should be pierced. On January 11, 2013, the Friday before the Monday on which trial of the State Court Action was to begin, and following almost three years of discovery, Sapphire commenced this bankruptcy, which led the judge presiding over the State Court Action to suspend the proceedings pending developments in the bankruptcy court. In the portion of its disclosure statement explaining why it filed for bankruptcy, Sapphire stated:

[T]his bankruptcy filing has been precipitated by the meritless, yet relentless, pre-petition litigation initiated by McKay against the Debtor. McKay’s pre-petition litigation has placed a cloud on the title and marketability of the Property, thereby depriving the Debtor’s legitimate creditors of a source of repayment on their claims. Indeed, the entire purpose of the State Court Action is McKay’s desire, albeit as discussed above misplaced, to transmogrify his claim against Longman individually into a claim against the Debtor’s estate that trumps all other creditor claims. The State Court Action also calls into question the priority of Hudson City’s secured claims. Accordingly, this bankruptcy case was commenced to effectuate the twin goals of bankruptcy: To ensure that all of the Debtor’s creditors are paid on an equitable basis, through the subdivision and sale of a portion of the Property, and to afford itself a fresh-start.

(Bankr. ECF No. 135, at 20.)[3] Soon after Sapphire’s filing, McKay moved in the bankruptcy court for dismissal of the case, relief from the automatic stay, and abstention.

Before the bankruptcy court issued a decision on McKay’s motions, Sapphire filed an adversary complaint seeking a declaration “that McKay does not possess a bona fide claim against Sapphire, and therefore, is not entitled to relief against the Debtor for any purpose, is not entitled to vote in or otherwise recover against the Debtor or its assets in Plaintiff’s Chapter 11 Bankruptcy case and[] otherwise[] lacks standing in this Case . . .” (In re Sapphire Dev., LLC, Adv. Pro. 13-05024 (Bankr. Conn.), ECF No. 1, at 4.) No action was taken in the adversary proceeding.

On May 10, 2013, Sapphire submitted a Disclosure Statement (Bankr. ECF No. 135) and Chapter 11 Reorganization Plan (Bankr. ECF No. 136). The bankruptcy court approved the Disclosure Statement on May 15, 2013 (Bankr. ECF No. 145), but did not act upon the Reorganization Plan. The Summary of Schedules lists four secured creditors: Hudson City ($2, 356, 614.00), J.P. Morgan Chase Bank ($500, 000.00), Savings Bank of Danbury ($3, 022, 763.00), and the Town of Ridgefield Tax Collector ($155, 572.32). (Bankr. ECF No. 36, at 6, as amended by Bankr. ECF Nos. 73, 75, 84, 132.) It lists six unsecured creditors, including Bethel Overhead Doors, LLC ($675.00), Gault Mason Supply ($8, 008.00), Mark Stern & Associates, LLC ($10, 000.00), O&G Industries ($6, 715.00), and Sloss Electric, LLC ($2, 000.00). (Bankr. ECF No. 36, at 9-10, as amended by Bankr. ECF Nos. 73, 75, 84, 132.) Longman is listed as a co-debtor for these unsecured claims. (Id. at 12.) McKay is listed as an unsecured creditor, but the value of his claim is listed as $0.00. (Id. at 10.)

A. Motion to Abstain

The bankruptcy court held a three-day evidentiary hearing on McKay’s abstention motion. McKay, Longman, and Christopher Mahler, a senior vice president and mortgage officer at Hudson City, testified at the hearing. During his testimony, McKay admitted that some of Sapphire’s creditors were not parties in the State Court Action. (June 20, 2013 Transcript, Bankr. ECF No. 199, at 86.) He stated that he was no longer seeking to “set aside” the Savings Bank of Danbury’s mortgage (id. at 109), and that neither the Savings Bank of Danbury’s nor J.P. Morgan Chase’s mortgage would be harmed if he prevailed in the State Court Action (id. at 116).[4] McKay admitted that the Property previously had been subdivided and sold successfully several times. (Id. at 90-91.) When asked why he preferred to litigate his claims in state court, McKay stated that he was seeking to “trump” Hudson City’s interest in the Property. (Id. at 118.)

Mahler testified that he was unaware of McKay’s judgment against Longman when he approved the mortgage in 2007. (July 24, 2013 Transcript, Bankr. ECF No. 217, at 11-12.) He also testified that Longman falsely told Hudson City that no judgments were pending against him when he submitted the mortgage documents. (Id. at 25.) Mahler was unaware when Hudson City accepted the mortgage that, within a matter of minutes on October 31, 2007, the Stewart Longman Family Trust transferred the Property to Sapphire, Sapphire issued the mortgage to Hudson City, and then Sapphire transferred the Property to Longman personally. (Id. at 16-19; McKay’s Abstention Hearing Exs. 15, 16, 18.)

During his testimony, Longman stated that upon purchasing the Property in 1985, he subdivided it into four parcels, and then later re-subdivided and sold those parcels, resulting in proceeds of approximately $4 million. (Id. at 45.) He did not specify the dates of those sales. He also recounted the lengthy series of transfers involving the Property since the initial 1985 acquisition: to Longman’s wife in 1995, to Highland Connecticut Investment, LLC, in 2002, to Sapphire in 2006, to the Stewart Longman Family Trust soon after, to Sapphire in October 2007, to Longman the same day, and then back to Sapphire in December 2007. (Id. at 45-51.) Longman testified that he has lived on the Property since 1985 without interruption (id. at 70), that Sapphire has had no employees since 2007 and has not filed any tax returns since 2006 (id. at 112), [5] and that the only funds Sapphire received in the 12 to 18 months prior to the bankruptcy were from entities owned or controlled by Longman: the Trust, Penguin Financial, and Luri Investments[6] (id. at 113-14). Longman also testified that the Town of Ridgefield had imposed a tax lien “for pre-filing taxes” in the amount of $100, 000. (Id. at 61.)

The bankruptcy court granted McKay’s motion for abstention under 11 U.S.C. § 305(a)(1). (Bankr. ECF No. 222.) In considering the “purpose for which bankruptcy jurisdiction was sought” - a factor relevant to whether abstention under Section 305(a)(1) is appropriate - the bankruptcy court made the following factual findings:

[Sapphire] is an artificial entity whose only purpose is to hold title to the Property, its only asset, which is not income producing. For the last three years (2011, 2012, and 2013) [Sapphire] has received contributions from the other related entities. It has not filed federal income tax returns for several years. The debtor has no employees and conducts no business. Without considering McKay’s [New York j]udgment, [Sapphire] has approximately $27, 000 in general unsecured claims, and for each of those unsecured creditors, Longman is identified as a co-debtor with [Sapphire]. Moreover, [Sapphire] has been making monthly mortgage payments to the first mortgagee, Hudson, and there are no foreclosure actions pending against it.
Therefore, it is open to considerable doubt whether the debtor needs to reorganize. Indeed, despite the debtor’s self-serving proclamation that “this bankruptcy case was commenced to effectuate the twin goals of bankruptcy: To ensure that all of [Sapphire’s] creditors are paid on an equitable basis, through the subdivision and sale of a portion of the Property, and to afford itself a fresh-start, ” it is reasonable to question that representation when there is no dispute that secured creditors are being paid and there is a nominal pool of general unsecured creditors for whom Longman is a co-debtor. Such suspicion is buttressed by [Sapphire’s] assertion that its “bankruptcy filing has been precipitated by the meritless, yet relentless, pre-petition litigation initiated by McKay against [Sapphire], ” notwithstanding that fact that the [New York j]udgment was base[d] on Longman’s “gross, wanton, and willful, ” conduct.
This Court has serious concerns that by filing for bankruptcy protection, the debtor is not just seeking to stay the State Court Action, but, by claiming McKay is not a creditor or even a party-in-interest, is also seeking to eradicate McKay’s ability to have his day in court, either here or in state court. Put another way, distilled to its pungent essence, [Sapphire] and Longman are attempting to lock McKay out of this court and the state court in an effort to avoid paying a judgment Longman owes to McKay for Longman’s affirmative fraud. Against that backdrop, Longman points his finger at McKay in this court of equity? The word chutzpah comes to mind. McKay is entitled to his day in court, but, for the reasons stated above, it is not this court.

(Id. at 6-8 (citations omitted).) Sapphire appealed. This Court reversed and remanded, holding that the bankruptcy court’s decision to abstain was premised on an erroneous view of Section 305(a)(1), which required that abstention be in the best interests of the “creditors and the debtor.” This Court found that because the debtor and one secured creditor (Hudson City) had an interest in maintaining the bankruptcy and because the unsecured creditors were not parties in the State Court Action, the bankruptcy court erred in abstaining under a provision that permitted it only if it was in the best interests of all creditors and the debtor. Sapphire Dev., 523 B.R. at 8, 10. This Court noted, however, that the bankruptcy court’s above-quoted findings regarding Sapphire’s intent in filing for bankruptcy were “supported by the evidence” and “would likely support granting either the motion to dismiss or the motion for relief from the automatic stay.” Id. at 12. This Court directed that, following remand, should the bankruptcy court find that dismissal or relief from the automatic stay was appropriate, any appeal be accompanied by a statement that it should be transferred to the undersigned.

B. Motion to Dismiss

After remand, the bankruptcy court addressed McKay’s motion to dismiss. Sapphire and Hudson City opposed the motion. The bankruptcy court informed the parties that in deciding the motion to dismiss, it would consider all evidence presented during the abstention hearing, as well as evidence to be presented at an additional evidentiary hearing on the motion to dismiss. No party objected. At the latter hearing, McKay called Betty Brosius, director of planning for the Town of Ridgefield, who testified that no formal application for subdivision with respect to the Property had been submitted to the Town Planning and Zoning Commission (the “Commission”). (April 14, 2015 Transcript, Bankr. ECF No. 312, at 18.) Brosius testified that the Commission had reviewed only a “presubmission concept” of the proposed subdivision informally. (Id. at 19-20.) Sapphire submitted “approved” minutes of a Commission meeting stating that, “[a]fter a brief presentation by Mr. Longman who stated that his proposal met the regulations and a short history of the property by Planner Brosius, Commission consensus was to favor the pre-submission concept of a proposed subdivision.” (Id.; Sapphire’s Mtn. to Dismiss Hearing Ex. 1.)

McKay then called Longman to testify. Longman testified that Sapphire’s only income since January 2014 had been from the Trust. (April 14, 2015 Transcript at 32-33.)[7] Longman testified that Sapphire’s income from August 2014 to February 2015 was less than $2, 000 a month. (Id. at 53-54.) When asked about a $100, 000 arrearage on Hudson City’s mortgage, Longman claimed that he had recently made a payment to Hudson City. (Id. at 54.) He could not, however, provide documentation of the payment. (Id. at 54-55.) On the second hearing date, April 16, 2015, Hudson City was unable to confirm such payment. (April 16, 2015 Transcript, ECF No. 313, at 36-41.) Longman also admitted signing operating reports stating that the source of Sapphire’s recent income was Lurie Investments when, in fact, the source was the Trust. (April 14, 2015 Transcript at 58-59.) He attributed this misstatement to the fact that his excel spreadsheets have “tiny print.” (Id. at 59.)

When asked why Sapphire filed for bankruptcy, Longman stated that the State Court Action did not include two major Sapphire creditors, and as a result, the Property could not be monetized in a way that treated all creditors fairly. (April 16, 2015 Transcript at 9.) Longman also testified that the Property was recently appraised at $5.5 million. (Id. at 16-17.) When asked why Sapphire had not submitted a formal subdivision plan to the Commission, Longman stated that he was under the impression that he could not make any such filings on behalf of Sapphire without the bankruptcy court’s permission. (April 14, 2015 Transcript at 60.) He stated that his informal presentation to the Commission resulted in no negative comments, which he believed meant there were “no discretionary obstacles” to the Commission’s approval. (April 16, 2015 Transcript at 18.) Longman testified that the entity listed as the funder of the reorganization plan, Penguin, was still willing to proceed with the plan. (Id. at 21-23.) A “balance sheet” submitted on behalf of Penguin indicates that it holds $16, 563, 583 in total assets and has zero liabilities.[8] (Bankr. ECF No. 135-15 (“Penguin Balance Sheet”).)

Longman did not dispute that the appraiser he cited in his testimony was not a member of the Appraisal Institute (“MAI”), [9] and that the appraiser had not provided a comparison value for the property as-is, i.e., without subdivision. (April 16, 2015 Transcript at 28-29.) He also conceded that one of the previous appraisals by MAI appraisers opined that the value of the Property without subdivision would be “almost exactly the same as the value subdivided.” (Id. at 29-30.)[10] That appraisal listed the value of the Property at $4.5 million unsubdivided, and at $4.6 million subdivided. (Bankr. ECF No. 135, at 15.) Longman also conceded that together, the Longman-controlled, single-member entities (Emerald, Sapphire, and Lurie) had a total negative income of approximately $1.5 million per year during the previous three years (id. at 32), and that Sapphire owed the Town of Ridgefield $281, 849.61 in delinquent taxes on the Property (id. at 34-35; McKay’s Mtn. to ...


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