Opinion
MEMORANDUM DECISION FOLLOWING EVIDENTIARY HEARING
ARTHUR S. WEISSBRODT, Bankruptcy Judge.
This matter comes before the Court on a motion to compel Debtor to make plan payments, to appoint a receiver, or to convert the case to Chapter 7. Debtor Silicon Valley Telecom Exchange, LLC (hereafter, "Debtor") is represented by attorney Marc Pinckney. Movant Campeau Goodsell Smith (hereafter, "CGS") - which represented Debtor in the bankruptcy case through confirmation of the Chapter 11 Plan - is represented by attorney Gregory Charles. Movant Law Offices of David Tilem (hereafter, "Tilem") is represented by attorneys Bernard Greenfield and Marcia Gerston.
At the heart of this dispute, the parties disagree about the proper method for calculating payments due under the confirmed Plan. This Court has been asked to determine several related issues, including: (1) whether Debtor has complied with the terms of Debtor's confirmed Chapter 11 Plan concerning payments to general unsecured creditors; (2) whether Debtor has complied with the terms of this Court's July 23, 2010 Order (hereafter, "the July 23, 2010 Order") on the parties' stipulation which clarifies Debtor's Plan payment obligations with regard to the general unsecured creditors; and (3) if Debtor has failed to comply with either the Plan or the July 23, 2010 Order, whether the Court should then convert the case to Chapter 7 or appoint a receiver to manage Debtor's business operations. Movants have also asked the Court to determine the appropriate method for calculating payments due to the general unsecured creditors under the Plan.
The Court held an evidentiary hearing. After the hearing, the parties submitted written briefs in the nature of closing argument. The Court has considered the evidence admitted at the hearing, the written and oral arguments of counsel, and matters of which this Court may take judicial notice. For the following reasons, the Court finds that some relief is appropriate and will compel Debtor to make Plan payments, but the Court will not order appointment of a receiver nor convert the case to Chapter 7, as requested by CGS and Tilem.
The evidentiary hearing occurred on several dates and was interrupted at the request of the parties so that they could engage in settlement negotiations.
I. Findings of Fact
A. The Confirmed Plan
Debtor commenced this bankruptcy case under Chapter 11 on October 22, 2001. However, a Chapter 11 plan was not confirmed until almost six years later. On August 24, 2007, after a hearing, the Court confirmed Debtor's Third Amended Joint Plan of Reorganization ("the Plan"). The Plan was a joint plan for three separate debtors: Rubio & Associates, Inc.; Silicon Valley Telecom & Internet Exchange, LLC ("SVTIX"); and Debtor Silicon Valley Telecom Exchange, LLC ("SVTX"). However, the Plan was confirmed only as to SVTX. Transcript ("Tr.") 179:21-25; 180:1-5.
The Court confirmed the Plan over objections from Tilem, as assignee of the claim of creditor Corporate Builders, Inc. (hereafter, "CBI"). The Court overruled Tilem's objections as untimely. The Plan's effective date was sometime in September 2007.
In questioning Mr. Rubio, Mr. Charles stated that the Plan was effective on September 20, 2007. Tr. 83:21-25.
Plan Execution
The Plan identifies the following means for the Plan's execution:
The funds necessary to implement the Plan will be derived from Debtor's post-Petition business operations and/or from monies on hand.
Debtor's Business Operations. The payments to be made to creditors under the Plan will be drawn from the proceeds of Debtor's operations. Debtor's expected operating results are set forth in Exhibit A to the Disclosure Statement, which is a pro forma income statement for the five year period of the Plan payments and which shows Debtor's anticipated financial condition from the Effective Date of the Plan. The projections anticipate that cash flow from operations after the Effective Date will be sufficient to meet Debtor's operating obligations and Plan obligations on an on-going basis. Debtor anticipates an increase in rents from lease of additional space available to SVTX as a result of Enron's termination of its leasehold interest, and Debtor anticipates an increase in rents from lease of space available to SVTIX.
Plan at ¶ IX. The Plan also specifies when payments to creditors are due, as follows:
Quarterly Payment Dates. The Plan provides for quarterly payments to claimants. Quarterly payments will be made within ten (10) days after January 1, April 1, June 1, and October 1 ("Quarterly Payment Date") of each calendar year after the Confirmation Date until claimants are paid in full as provided for by this Plan. The first quarterly payment will be made the first Quarterly Payment Date that occurs 90 days after the Confirmation Date.
Id.
If Debtor fails to make payments as required by the Plan, the Plan provides what will occur in the event of a default:
Default. In the event that the Reorganized Debtor defaults in the performance of its obligations under this Plan, and shall not have cured such default within a period of ten (10) days after receipt of written notice of default from the holder of any allowed claim, then the holder of such allowed claim may pursue such remedies as are permitted by law.... If there is a material default under the terms of the plan and upon a successful post-confirmation motion to convert this case to a case under Chapter 7 of title 11, this plan shall terminate, and the Chapter 7 estate shall consist of all remaining property not already administered.
Id.
Under the Plan, the Court has retained jurisdiction to resolve any dispute regarding the interpretation of the Plan, to enforce and implement the Plan, to enter orders "in aid of consummation" of the Plan, and to modify the Plan under 11 U.S.C. § 1127, among other things not applicable to the instant motion. Id. at ¶ X.
Required Payments Under Plan
The Plan requires Debtor to pay all allowed general unsecured claims from multiple sources. These unsecured creditors are to share, on a pro rata basis, in the following: an Effective Date Payment of $50,000.00; distributions from Enron's Chapter 11 bankruptcy case, including an amount of $192,302.74 already collected; and any preference recoveries. Significant to the instant matter, each creditor is also entitled to quarterly payments consisting of a "pro rata distribution of 80% of the net proceeds of Debtor's on-going operations, which payments shall continue until claimant is paid in full for the principal amount of its claim plus interest accruing at the Federal Rate." Plan at ¶¶ VI.D through VI.L.
The Plan and Disclosure Statement identify the following holders of general unsecured claims: CB Richard Ellis, Granite Capital/Telegis, CBI, Verio, Inc., Fernando (aka Fred) and Karen Rubio, Michael Oaks, and NTT America. Debtor's Addendum to the Disclosure Statement filed August 17, 2007, identifies the amounts owed to each of the unsecured creditors, as follows: CB Richard Ellis ($65,435.09), Granite Capital ($102,245.52), CBI ($500,000.00), Verio, Inc. ($180,389.70), Fred and Karen Rubio ($0.00), Michael Oaks ($30,000.00), and NTT America ($30,000.00).
Enron's involvement is discussed more fully infra.
By contrast, the Addendum to the Disclosure Statement stated that the source of the payments will be "80% of the net profit of Plan Proponents' business operations (the remaining 20% of net profits will be held in a reserve account for payment of unanticipated expenses)." Addendum at p. 3, lines 4-8.
Debtor, CGS, and Tilem disagree as to the meaning of "net proceeds." In his testimony, Scott Goodsell agreed that the term "net proceeds from ongoing business operations" was a term drafted by Mr. Goodsell, and that the Plan does not define "net proceeds." Tr. 293:13-25. Prior to confirmation, Mr. Pinckney (then of CGS) agreed in open court at the hearing held August 24, 2007, that "profits" would mean "proceeds" under the Plan, but no such definition was ever incorporated.
In addition to being an attorney with CGS, Mr. Goodsell is also a Certified Internal Auditor. Tr. 146:18-21. Mr. Goodsell described this certification as being equivalent to a Certified Public Accountant. Tr. 146:19-25. However, CGS's attorney declined to offer Mr. Goodsell as an accounting expert, after counsel for Debtor objected. Tr. 175:7-17.
It was CGS's attorneys who drafted the Plan and Disclosure Statement in this case. Tr. 186:22-25; Tr. 187:1-3. One of the primary authors of the Plan was Debtor's attorney, Scott Goodsell of CGS. Tr. 153:7-9. However, according to Mr. Goodsell, the Third Amended Plan was drafted by attorney Marc Pinckney, who at the time worked for CGS. Tr. 293:9-12.
With regard to the main bankruptcy case, attorneys at CGS continued to represent Debtor through confirmation of the Plan until at least September 2007. Mr. Pinckney advised that CGS continued to represent Debtor in 2008 in Adversary Proceeding No. 08-5001. However, it was Mr. Pinckney - not Mr. Goodsell - who filed the interpleader complaint on January 2, 2008. At the time, Mr. Pinckney still worked for CGS.
Complicating the absence of a definition is the fact that "net proceeds" is not an accounting term. Debtor's accountant, Laurie Orlando- who testified that she has not seen the Plan - stated that "net proceeds" is not an accounting term and therefore would need to be defined. Tr. 364:3-4; Tr. 366:1-3. The absence of a clear definition of "net proceeds" was raised by Tilem in his objection to confirmation, but because the objection was untimely, the issue has not been addressed until now.
By contrast, Ms. Orlando testified that "net profit" is an accounting term, but did not define the term. Tr. 378:20-22; Tr. 379:14. Ms. Orlando also testified that the term "net income" is different from "net profit." Tr. 382:7-8 and 18-24; Tr. 383:16-21; Tr. 384:5-10 and 22-25.
Even without a clear definition, the parties' attributed similar, but not identical, meanings to the term "net proceeds." Fred Rubio, II, the principal, owner, and manager of Debtor, testified that the Plan required Mr. Rubio "to pay on a quarterly basis... the creditors, after looking at a cash basis, 80 percent of the net proceeds" and that "20 percent basically goes to a reserve account." Tr. 25:11-14; Tr. 51:8-21. Mr. Rubio also testified that he had discussions with his accountants, Ms. Orlando and Victoria Martini, to determine what the term "net proceeds" means. Tr. 26:24-25 and 49:1. Mr. Rubio understood that "net proceeds" were the "net profits after all expenses are paid" for a particular time period - or "income minus expenses." Tr. 116:8-13. Mr. Goodsell agreed with Mr. Rubio's definition, and added that regular operating expenses should be subtracted from gross proceeds to obtain net proceeds. Tr. 160:13-17; Tr. 222:5-11. According to Mr. Goodsell, operating expenses would not include major renovations, improvements, or repairs. Tr. 163:16-12; Tr. 300:15-23; Tr. 465:23-25; Tr. 466:1.
Mr. Rubio's actual name is Fernando Rubio, Jr., but he uses the name Fred. Tr. 527:20-21; Tr. 528:18.
The purpose behind the 80%/20% split in the Plan was to ensure that creditors would be paid, while at the same time setting aside some funds for the Debtor to use for improvements or repairs. Tr. 153:22-25; Tr. 154:1-4; Tr. 163:16-20. Debtor's Disclosure Statement, including the Addendum thereto, explained that the remaining 20% would be "held by Debtor as a reserve to pay for unanticipated but necessary building repairs or other expenses necessary for the preservation of Debtor's operations[.]" DS at p. 12, lines 9-12. Attached to the Disclosure Statement was a Cash Flow Analysis projecting quarterly payments ranging from $70,363.00 to $667,219.05 to the general unsecured creditors from the second quarter of 2003 through the first quarter of 2008. The Cash Flow Analysis did not project any major repairs or improvements. Mr. Rubio agreed that Debtor projected no capital expenses between April 1, 2006 and March 31, 2011, in evaluating Debtor's present value for purposes of the Disclosure Statement. Tr. 73:9-25; Tr. 74:1-13.
The Disclosure Statement (or "DS") was entitled "[Third Amended] Disclosure Statement on Joint Plan of Reorganization."
At the hearing, Mr. Goodsell testified that he did not believe that Debtor could make principal and interest payments to San Jose National Bank as part of Debtor's operations, and that payments toward principal could not be deducted before calculating net proceeds. Tr. 438:7-16. Mr. Goodsell believed that the meaning of "net proceeds" later changed such that the principal payments could not be deducted. Tr. 445:1-12; Tr. 446:1-2; Tr. 447:25 to 448:9. The Court finds such testimony to be disingenuous, at best, because it is contradicted by the Plan, drafted by attorneys at CGS, which requires Debtor to pay the principal obligation. The testimony is also contradicted by the Cash Flow Analysis submitted with the Disclosure Statement. The Cash Flow Analysis shows that Debtor anticipated the entire payment to San Jose National Bank - along with other amounts paid, such as rent, insurance, taxes, utilities, landscaping, payroll, and similar expenses - would be excluded before calculating the 80% amount payable to creditors. This treatment of the payment to San Jose National Bank, including the principal reduction payments, was fully disclosed to all creditors prior to confirmation. Regardless, the propriety of the payment to San Jose National Bank is not the central issue before this Court. Apart from the complaints made by CGS, there have been no other objections to these payments.
B. Debtor's Business
Rubio and Associates, a business operated by Fred Rubio, II, leased a warehouse located at 250 Stockton Street, San Jose, California ("the Property"), from the San Jose Unified School District starting in 1999. Tr. 123:8-13; Tr. 255:2-6. In 1999, Mr. Rubio formed Debtor and became Debtor's managing member. Tr. 528:5-7 and 16-18; Tr. 529:9. Debtor took over the master lease of the Property for purposes of operating a co-location facility on the premises. Tr. 180:7-12. According to Mr. Rubio, a co-location facility is a data center where different companies place their computer servers and sometimes outsource maintenance and management. Tr. 532:17-23. Debtor leased parts of the facility to various tenants, including Enron, Verio, and NTTA. Tr. 180:13-15. The master lease will expire in April or May 2019, but has a five-year option to renew. Tr. 598:22-24.
At the hearing on November 22, 2011, Mr. Goodsell testified that the master lease "probably has about 10 years to run." Tr. 255:7-9.
In 2000, Mr. Rubio formed SVTIX and became SVTIX's managing member. Tr. 528:24-25; 529:1 and 10-12. The purpose of SVTIX was to oversee the "meet me room," a large utility room where the carriers (such as AT&T, Verizon, and others) reside. Tr. 531:11-23; Tr. 534:7-11. SVTIX rents space on the first floor of the Property, colloquially referred to as "the basement." Tr. 181:3-11.
Mr. Rubio manages and operates Debtor's and SVTIX's business on the Property. Tr. 123:14-25; Tr. 124:5-19; Tr. 529:2-6. Mr. Rubio testified that Mr. Rubio was in charge of Debtor's day-to-day finances until the accountants took over that responsibility in September 2009. Tr. 59:20-22; Tr. 117:1-8. Mr. Rubio works in real estate, and is neither an engineer nor an accountant. Tr. 120:25 to 121:6-12.
It is Mr. Rubio's wife, Karen Rubio, who keeps Debtor's books, receives the rent and other income, writes and records checks, and calculates the quarterly Plan distributions. Tr. 529:18-25; Tr. 530:1-14. To accomplish these tasks, Ms. Rubio uses QuickBooks Pro, on which she has received some training. Tr. 602:11-19. However, Ms. Rubio is not an accountant and does not know definitions for all accounting terms, such as "amortization." Tr. 603:11-12; Tr. 615:24-25. Ms. Rubio recalled "glancing" at the Plan, but confessed that she has not read the Plan in depth and has not reviewed the amended Disclosure Statement. Tr. 617:7-14. Ms. Rubio testifed that in deciding how much money to pay to CGS under the Plan, Ms. Rubio had no instruction; instead, Ms. Rubio simply took the cash balance for the companies and subtracted "imminent expenses." Tr. 623:10-17.
Debtor pays a total salary to Mr. and Ms. Rubio of $15,000 per month. Tr. 258:21-25; Tr. 259:1-2. Debtor has also paid other members of the Rubio family for work performed at the Property. According to Mr. Rubio, Starting in 2010, two of Mr. and Ms. Rubio's three sons - Fred, Ryan, and Eric - worked for the Debtor as Building Operating Center Technicians. Tr. 75:19-24; Tr. 76:23-25; Tr. 77:5-9. In that role, the sons performed "reboots" and "KVM," swapped hard drives, took down firewalls, and traced network cables. Tr. 76:1-3. At one point or another, all three of Mr. Rubio's sons worked for Debtor. Tr. 121:22 to 122:6. Mr. Rubio set his sons' rates of pay. Tr. 76:14-15. Some of the sons' high school friends also worked for Debtor performing landscaping and painting work. Tr. 77:16-20; Tr. 122:10-13. According to Mr. Goodsell and Mr. Rubio, Debtor also pays a woman named Jackie Fitzpatrick a fixed monthly commission to bring in new clients. Tr. 127:14-25; Tr. 128:1-2; Tr. 259:12-16; Tr. 260:1-2. In 2008, the commission was $10,000.00 per month. Tr. 127:25; Tr. 128:1.
It was not clear from the testimony when Ms. Fitzpatrick began to work for Debtor. The commission paid to Ms. Fitzpatrick was not listed on the Cash Flow Analysis submitted with the Disclosure Statement prior to confirmation.
In 2001, one of the tenants at the Property - Enron - filed for Chapter 11 bankruptcy and rejected Enron's lease with Debtor. Tr. 181:17-22; Tr. 534:14-20. Enron vacated the Property and abandoned approximately $20 million in equipment, all of which was built into the Property. Tr. 534:17-20; Tr. 536:24-25; Tr. 537:1; Tr. 537:6-11. After Enron departed, SVTIX assumed responsibility for the operation of the Enron equipment. Tr. 540:6-9. SVTIX was unable to lease the entire space vacated by Enron, but was able to lease "lots and lots and lots of cabinets." Tr. 538:6-14. To the new tenants, SVTIX provided maintenance and management of the tenants' equipment, such as rebooting computers and performing an operation called "keyboard, video, and mouse" (KVM), which allows customers from around the world to monitor the customers' equipment from remote locations. Tr. 540:15-24; Tr. 541:7-19.
Mr. Rubio testified that Debtor made leasehold improvements at the Property in 2007. The improvements included building out the cabinets and racks, adding electrical infrastructure to some of the Enron rooms, bolting down the cabinets and ladder racking, and building up the data centers. Tr. 63:14-23.
According to Mr. Rubio, Debtor spent between $47,000 and $48,000 on cost of goods sold in 2007. Tr. 65:10-12. Mr. Rubio also testified that in 2008, 2009, and 2010, Debtor spent a bit more than $23,000, $18,000, and $20,000, respectively, on cost of goods sold. Tr. 65:13-18.
Mr. Rubio also testified about the difference between maintenance and repairs. Tr. 66:10-15. Mr. Rubio stated that maintenance pertains to maintaining existing electrical infrastructure, such as servicing the generators, the UPS, and the electrical systems. Tr. 66:10-15. By contrast, a repair involves repairing an existing broken item, such as a broken pipe, a damaged fence, leaking batteries, or air conditioning systems. Tr. 66:10-15. Mr. Rubio further stated that repairs are not improvements. Tr. 67:1-2.
UPS stands for "uninterrupted power supply." Tr. 542:2-5. Each UPS serves as a battery backup system which protects against losses caused by power outages. Tr. 128:22-24; Tr. 593:24-25; Tr. 594:1-3.
According to Mr. Rubio, Debtor spent $41,822.95 on contractors in 2007, $230,572.69 on contractors in 2008, $201,836.08 on contractors in 2009, and $76,059.46 on contractors in the first half of 2010. Tr. 67:5 to 68:2; Tr. 70:11-19; Tr. 72:1-9. Mr. Rubio clarified that contractors were entities that were "building things at the building." Tr. 68:5-7. Mr. Rubio stated that the type of work performed by the contractors could be repairs, maintenance, or "new installs." Tr. 68:19-22. Ms. Rubio verified that contractor expenses included monthly service and maintenance contracts. Tr. 606:3-15.
Of the $41,822.95 spent on contractors in 2007, Mr. Rubio testified than none was spent on new infrastructure, but instead was used to expand the existing infrastructure in the Enron Data Center. Tr. 69:15-17; Tr. 70:11-24. In 2008, Debtor spent $230,572.69 on infrastructure improvements; Debtor bought a new UPS system and installed rows of cabinets, cages, and ladder racking. Tr. 69:18-19; Tr. 71:4-14; Tr. 72:1-3. The UPS system purchased in 2008 - which Debtor referred to as "UPS Charlie" - was installed in the summer of 2008 at a cost of $115,000.00. Tr. 542:24-25; Tr. 543:1-4 and 16-18. According to Mr. Rubio, once UPS Charlie was installed, there were customers who needed to use it, and UPS Charlie began to generate $33,000.00 per month. Tr. 543:5-13. Within a few months, UPS Charlie had paid for itself.
Between confirmation of the Plan and the end of 2008, Mr. Rubio agreed that Debtor performed speculative improvements to the building in the hope of attracting new tenants, which included a new transformer at a cost of $38,000.00, with a $26,000.00 installation cost. Tr. 128:16-21; Tr. 130:1-3. Mr. Rubio also agreed that Debtor replaced at least one UPS system at a cost of $28,000.00, plus $15,000.00 in installation costs. Tr. 128:22 to 129:12. Debtor also installed lighting ballasts outside because NTTA complained that women were being accosted in the parking lot. Tr. 129:13-21. According to Ms. Rubio, Debtor also had security expenses, which were the main item charged under the "consulting expenses" category. Tr. 604:12-14. Ms. Rubio also explained that the consulting category did not include expenses for construction of improvements, such as the installation of UPS systems. Tr. 604:21-25; Tr. 605:1-3. Instead, any large equipment purchases-such as the UPS systems or replacement transformers - would be charged as a fixed asset expense. Tr. 606:20-25; Tr. 607:1-5.
In 2009, Debtor spent $201,836.08 on infrastructure improvements on the air conditioning system, as well as on "walls in the power room in the basement." Tr. 69:20-23; Tr. 72:4-6. In the first half of 2010, Debtor spent $76,059.46 on infrastructure improvements. Tr. 72:7-9. Mr. Rubio also testified that Debtor purchased another UPS system - "UPS David" - in 2010 for approximately $115,000.00 to $120,000.00. Tr. 544:16-24; Tr. 545:2-3. However, Mr. Rubio stated that only 16 to 17 percent of UPS David was rented out to customers, because Mr. Goodsell told Mr. Rubio to cease spending money on construction in May 2010 to avoid violating the terms of the Plan. Tr. 545:12-24; Tr. 547:25; Tr. 548:1-6; Tr. 549:21-24; Tr. 550:17-23.
Mr. Rubio testified that without further construction, the remainder of UPS David could not be leased to customers. Tr. 551:5-14. Mr. Rubio also stated that Debtor ceased purchasing cabinets and power for UPS David, even though those costs would have been reimbursed by any customers. Tr. 553:18-25. Debtor purchased $22,000.00 in cabinets in April 2010, which allowed for a portion of UPS David to be leased. Tr. 576:20-25. Slightly more than this amount was reimbursed through non-recurring charges to the customers. Tr. 577:12-15; Tr. 609:21-25. Mr. Rubio believed that if the construction had taken place, Debtor would have been able to lease all of UPS David. Tr. 554:20-22. In other words, Mr. Rubio believed that if Debtor had been allowed to build out UPS David, the construction would have paid for itself.
Mr. Goodsell testified that two of Debtor's "big footprint tenants" - Verio and NTTA - left the property in May 2010 and were never replaced with other "big footprint tenants." Tr. 243:1-5; Tr. 244:7-12. As a result, Debtor's revenues declined. Tr. 243:1-5; Tr. 258:7-20. According to Mr. Goodsell, the revenue stream from Verio and NTTA was sufficient - in fact critical - to fund the Plan, but when Verio and NTTA left the Property, it became highly unlikely that creditors would be paid. Tr. 243:7-19.
According to Mr. Goodsell, the revenue from Verio and NTTA was "probably 75 grand a month, maybe more[.]" Tr. 258:11.
Mr. Rubio acknowledged that rents dropped significantly after Verio and NTTA left the Property, and that Debtor needed to replace these rents in order to remain solvent. Tr. 556:20-24; Tr. 574:6-8. Verio had been paying monthly rent of $55,000.00, and NTTA had been paying monthly rent of $35,000.00. Tr. 557:6-21. In addition, both Verio and NTTA had paid a pro rata share of taxes, insurance, and other expenses. Tr. 557:6-21. Mr. Rubio explained that Debtor had been unable to attract tenants to the space left vacant by Verio and NTTA because of soil contamination located near diesel power generators, which was disclosed to Debtor in May 2010, and which Verio agreed to remediate. Tr. 558:4-15; Tr. 559:14-25; Tr. 561:3-14. Mr. Rubio testified that some remediation was performed, but the Property is still not leasable because the San Jose Fire Department and Santa Clara County Health Services have not provided a closure letter stating that the Property is clean. Tr. 562:4-7; Tr. 565:7-25. Also, the diesel generators have not been inspected, and Verio and NTTA have been unwilling to perform any testing of the generators. Tr. 566:20-25; Tr. 567:16-24. According to Mr. Rubio, the soil contamination is the subject of a lawsuit now pending in federal court. Tr. 567:24-25.
According to PACER, the district court case is Case No. 12-cv-00899-HRL, and remains pending.
Both Debtor and SVTIX hired Ms. Orlando, a Certified Public Accountant, to prepare tax returns for tax years 2007, 2008, and 2009. Tr. 334:15-17; Tr. 335: 10-22. To prepare the returns, Ms. Orlando obtained balance sheets, income statements, and loan documentation from Karen Rubio. Tr. 336:6-11. According to Ms. Orlando, for tax year 2007, Debtor and SVTIX's combined income was $2,155,465.00, but the cost of sales and direct expenses were $1,315,785.00, after disregarding intercompany charges for rents and utilities. Tr. 355:5-7; Tr. 359:11-16. Similarly, for tax year 2008, Debtor and SVTIX's combined income was $2,530,079.00, with cost of sales and direct expenses of $1,608,281.00. Tr. 355:8-11; Tr. 359:17-18. For tax year 2009, Debtor and SVTIX's combined income was $3,330,676.00, with cost of sales and direct expenses of $2,045,262.00. Tr. 359:3-7 and 19-20.
C. Payments to Creditors
CGS and Tilem are creditors. Tilem is a creditor of claimant CBI and thus claims to be a general unsecured creditor. By contrast, CGS is a creditor due to the attorney's fees owed by Debtor.
Approximately four months after the Plan was confirmed, on December 28, 2007, CGS filed an application with the Court seeking $1,238,814.68 for services performed and costs expended during the case. If approved, this would have brought the total fees paid in the case to $1,819,701.20, and the total expenses to $45,260.59. On March 19, 2008, the Court issued an order authorizing interim compensation to CGS in the amount of $400,000.00, to be split between Debtor, SVTIX, and Rubio & Associates. At a hearing held July 17, 2008, Debtor, CGS, and interested parties SVTIX and Rubio & Associates, agreed that the net fees and costs remaining to be paid by Debtor (SVTX) were $948,033.97 and $45,260.59, respectively. Debtor, CGS, and the interested parties also agreed that the fees and costs to be paid for the interpleader proceeding were $4,000.00 and $313.00, respectively. As of November 22, 2011, Debtor continued to owe CGS approximately $410,000 in fees. Tr. 253:23-25. That amount continues to accrue interest at the Federal Rate, as specified by the Plan. Tr. 254:1-4.
Mr. Rubio testified to his understanding that CGS is to be paid before any other creditor. Tr. 134:14-25 and 135:1-10. Mr. Goodsell confirmed that CGS's claim is to be paid "as an administrative claim" before any payment to unsecured creditors. Tr. 293:3-7. The parties filed a Joint Pretrial Statement in which the parties stipulated to the following facts concerning Debtor's cash balances and amounts actually paid to CGS:
Calendar Debtor's SVTIX Balance Amount Paid to CGS Quarter (SVTX) Sheet Cash Ending Balance Balance Date Sheet Cash Balance 12/2007 $161,597.18 $41,664.05 $0.00 3/2008 $40,017.90 $85,072.39 $87,268 on 2/15/08 6/2008 $62,347.51 $25,387.66 $0.00 9/2008 $82,255.87 $43,429.54 $0.00 12/2008 ($48,433.90) ($113,852.82) $219,000 on 12/28/08 3/2009 $98,195.83 $45,296.57 $0.00 6/2009 $32,223.79 $88,696.96 $50,000 on 7/14/09 9/2009 $96,770.48 $13,476.00 $19,500 on 10/30/09 12/2009 $79,318.49 ($46,324.24) $198,159.06 on 12/29/09 and 12/30/09 3/2010 $17,167.26 $196,815.96 $158,916.67 on 4/7/10 and 5/19/10 6/2010 $596.14 $15,996.43 $13,274.05 on 7/8/10 TOTAL $746,117.78 PAID TO CGS
It is Debtor's contention that calculation of the amount due to creditors should be premised upon a "balance sheet cash balance." By contrast, CGS and Tilem assert that the calculation should be premised upon "reported SVTX cash basis profits." The parties' joint statement provides that the difference between these two methods is that Debtor's calculation includes checks which have been written but not yet presented to the bank for payment, while CGS and Tilem do not factor unpresented checks into the calculation.
Mr. Rubio testified that he first heard the term "balance sheet cash balance" in the later part of 2009 from accountants Victoria Martini and/or Laurie Orlando. Tr. 115:16-19 and 116:1-2.
Notwithstanding Debtor's assertion that the calculation of the amount due should be based upon the balance sheet cash balance, the above table shows that in most quarters, Debtor, together with SVTIX, paid CGS less than 80% of the balance sheet cash balance. However, there were quarters in which Debtor made a payment to CGS despite a negative balance sheet cash balance - for instance, the quarters ending December 2008 and December 2009.
It is difficult to calculate the precise amount which Debtor should have paid to CGS, but the parties' data allow for an estimate. Based upon the parties' stipulated figures, the Court has calculated that if Debtor and SVTIX had segregated 80% of each balance sheet cash balance for CGS, the following amounts could have been available to pay CGS:
The Court qualifies this finding, because there were quarters in which Debtor posted negative balance sheet cash balances due to payments made to CGS during those quarters.
Calendar 80% of Debtor's 80% of SVTIX's Total Available Quarter Ending (SVTX) Balance Balance Sheet for CGS Date Sheet Cash Cash Balance Balance 12/2007 $129,277.74 $33,331.24 $162,608.98 3/2008 $32,014.32 $68,057.91 $100,072.23 6/2008 $49,878.00 $20,310.13 $70,188.13 9/2008 $65,804.70 $34,743.63 $100,548.33
12/2008 NA NA NA 3/2009 $78,556.66 $36,237.26 $114,793.92 6/2009 $25,779.03 $70,957.57 $96,736.60 9/2009 $77,416.38 $10,780.80 $88,197.18 12/2009 $63,454.79 NA $63,454.79 3/2010 $13,733.81 $157,452.76 $171,186.57 6/2010 $476.91 $12,797.14 $13,274.05 Total $981,060.78
There was a negative balance of $48,433.90 because Debtor paid CGS $49,000. Thus, in this quarter it would seem that Debtor paid CGS more than 80% of the balance sheet cash balance.
There was a negative balance of $113,852.82 because SVTIX paid CGS $170,000.
There was a negative balance of $46,324.24 after SVTIX paid CGS.
The Court's calculation of the amount which might have been available to pay CGS is, necessarily, a rough one. However, if the Court were to adopt Debtor's position that the calculation of the amount due to CGS should be based upon the balance sheet cash balance, Debtor may have underpaid CGS by approximately $234,943.00 ($981,060.78 minus $746,117.78) between December 2007 and June 2010.
Mr. Goodsell testified that Debtor should have paid, but did not pay, the sum of $819,054.02 to CGS. Tr. 433:10-16. This figure appears on Exhibit 7 - an exhibit which Mr. Goodsell compiled - next to the heading: "Cumulative Monies Diverted from Creditors." Exhibit 7 specifically contains the following information regarding what Mr. Goodsell contends should have been allocated to creditors and to the reserve fund, and what amounts were actually paid:
The actual payout numbers are not correct. See Tr. 493:12-25 and 494:1-10.
Time Net Income 80% for Creditors/ 20% Reserve Period (Amount Actually Paid) Jan-Dec $113,992.45 $91,193.96/(NA) $22,798.49 07 Jan-Dec $612,495.23 $489,996.18/($306,268.00) $122,499.05 08 Jan-Dec $1,031,853.27 $825,482.62/($267,660.06) $206,370.65 09 Jan-Jun $295,524.94 $236,419.95/($158,916.67) $59,104.99 10 Totals $2,053,865.89 $1,643,092.71/($732,844.73) $410,773.18
The data for Jan-Dec 07 are inaccurate and do not reflect the confirmation of the Plan, which occurred in August 2007. The 80/20 split did not go into effect until after confirmation.
The $819,054.02 figure appears to be premised upon the following mathematical calculation: $1,643,092.71 (the 80% for creditors) minus $732,844.73 (the amount actually paid to creditors) minus $91,193.96 (the amount allocable to calendar year 2007).
The figures reached by Mr. Goodsell in Exhibit 7 are somewhat inflated and are premised upon suspect data; therefore, the Court gives Exhibit 7 little weight. In compiling Exhibit 7, Mr. Goodsell attempted to "back out" or "add back" what he deemed were improper purchases. For instance, Mr. Goodsell included in "net income" any funds which Mr. Goodsell believed Debtor was not authorized to spend prior to the 80/20 split - including funds actually spent on the UPS systems, approximately $105,000.00 spent on consulting, and approximately $230,000.00 spent on contractors - which Mr. Goodsell believed should have been purchased with the 20% reserve funds. Tr. 452:7-10; Tr. 453:18-25; Tr. 454:13-18 and 23-24; Tr. 458:1-5; Tr. 459:2-5; Tr. 474:13-20; Tr. 475:21-23; Tr. 476:19-25. However, Mr. Goodsell acknowledged that it was possible that some of the Debtor's expenditures, such as UPS Charlie, may have led to additional income, and that Mr. Goodsell included such income in the net figures. Tr. 453:18-25; Tr. 457:5-6. Mr. Goodsell also testified that any add-back likely would have been reduced or offset by any of Debtor's expenses which were reimbursed by customers. Tr. 461:6-23; Tr. 464:2-7.
Mr. Goodsell compiled Exhibit 7 using information from Exhibit 5. However, Exhibit 5 was not admitted into evidence nor authenticated. When questioned about Exhibit 5, Ms. Rubio did not know who prepared it. Tr. 604:2-5; Tr. 649:17-19.
Mr. Goodsell explained that the add-back for consulting and contractors included amounts paid for improvements, equipment, and repairs, but not amounts paid for ordinary expenses. Tr. 464:11-24; Tr. 475:21-23; Tr. 476:19-22.
Mr. Rubio testified that in determining how much money would be paid to CGS or to creditors under the 80/20 split provided for in the Plan, Mr. Rubio deducted amounts that were paid to contractors before determining the percentages. Tr. 75:1-4. Mr. Rubio also stated that no distribution was made in January 2008 because there was a dispute as to CGS's fee application, and because Mr. Rubio needed to determine what amounts were needed to pay for taxes and insurance. Tr. 81:10-22; Tr. 91:5-12. Mr. Rubio stated that the funds were available to pay CGS, but Mr. Rubio did not place the funds in escrow. Tr. 92:5-7; Tr. 94:2-3 and 9-10; Tr. 96:13-16. Mr. Rubio acknowledged that the funds were used to pay for "some unexpected expenses." Tr. 96:25 to 97:2. According to Mr. Rubio, when Debtor paid CGS at the end of 2008, Debtor's accounts were emptied. Tr. 95:17-18.
According to Mr. Rubio's testimony, at least some of the amounts paid to contractors included maintenance, in addition to repairs and installations. Tr. 66:9-15; Tr. 68:16-22.
According to Mr. Goodsell, between May 2010 and November 2011, Debtor paid CGS approximately $15,000.00 to $20,000.00 in attorney's fees. Tr. 256:4-11. Mr. Goodsell projected that if Debtor's payments to CGS proceeded at the same pace, Debtor's debt to CGS would not be paid in full by the termination of the master lease. Tr. 255:10-13.
The Addendum to the Disclosure Statement projected that all unsecured creditors would be paid in full within three years or less of confirmation. Addendum at p. 6, lines 6-10. However, in the more than five years since confirmation of the Plan, Debtor has paid nothing to the unsecured creditors from Debtor's business income. Tr. 134:9-17; Tr. 135:12-18; Tr. 142:18-21. Rather, Debtor has disbursed payments to the unsecured creditors of all funds Debtor received from Enron. Tr. 607:6-16; Tr. 630:7-11; Tr. 639:2-9. Ms. Rubio believed that apart from the Enron money, no other money was to be distributed to creditors, regardless of how profitable Debtor's business was. Tr. 617:21-25. The total amount of the Enron distributions was not offered into evidence.
D. The Motion to Compel
On October 21, 2009, CGS filed a motion seeking to compel Debtor to make payments under the Plan, or seeking an order to appoint a trustee or receiver. See Tr. 144:4-10. According to the motion, Debtor failed to distribute funds in the manner required by the Plan. The motion was joined by creditor David Tilem, who represented creditor CBI, and also joined by creditor Randall Lamb Associates, one of four assignees of CBI's claim. On November 9, 2009, Debtor filed a brief opposing the motion.
Randall Lamb Associates filed a joinder in CGS's motion on November 2, 2009, and filed another document reaffirming such joinder on April 27, 2011. However, Randall Lamb Associates did not participate in the hearing on the motion and has not submitted any argument papers of its own.
In May 2010, the parties agreed upon a methodology for calculating the payments due under the Plan. This agreement was later incorporated into the July 23, 2010 Order. The parties' agreement - and the July 23, 2010 Order - require Debtor to prepare quarterly balance sheets with three separate cash line item accounts: (1) a tenant prepaid rents liability account ("the Rents Account"); (2) a 20% reserve account ("the Reserve Account"); and (3) a general cash account ("the General Account").
The Rents Account was to reflect rents or license fees received by Debtor 30 or more days before the month for which the rent or fee was being paid. Such rents and fees would then be moved into the General Account. The Reserve Account was to reflect the cumulative unspent balance of the Reserve Account from the current and previous quarters, as well as customer and tenant reimbursements for expenses paid out of the Reserve Account.
Funds in the Reserve Account could be used for repairs or improvements to the Debtor's property located at 250 Stockton Ave., San Jose, California, could be transferred to the General Account to cover normal operations, or could be distributed to creditors. From the General Account, all ordinary expenses could be paid, as well as any individual repair costing $1,000.00 or less. Repairs costing more than $1,000.00 and any building improvements were to be paid from the Reserve Account.
However, if there were insufficient funds in the Reserve Account to pay for a required repair, then funds from the General Account could be used, with immediate notification to be given to Scott Goodsell and Marcia Gerston. If there were insufficient funds for a required building improvement, Debtor could request, in writing, the use of General Funds. Such building improvement would require advance approval of Scott Goodsell or Marcia Gerston. However, use of the General Account funds for a non-repair expense would otherwise be a breach of the Plan. Under the parties' stipulation, approval by Mr. Goodsell or Ms. Gerston "shall not be unreasonably withheld." See Joint Status Statement, p. 3.
Mr. Goodsell testified that Debtor could not make a major repair if there were insufficient funds in the 20% reserve account. Tr. 464:19-25; Tr. 465:1-25; Tr. 466:1. In so testifying, Mr. Goodsell made no mention of the possibility that Debtor could obtain approval to use non-reserve funds for a major repair. Perhaps Mr. Goodsell anticipated that any request for approval would be denied, but it is not clear from Mr. Goodsell's testimony.
The parties' agreement, and the July 23, 2010 Order, clarify that the quarterly distribution to the general unsecured creditors is to consist of 80% of the of the total in the General Account at the end of the quarter. In addition, Debtor is required to provide copies of quarterly profit and loss reports, quarterly balance sheets, check registers, and a report listing tenants and the amounts of prepaid rents by tenant in the Rents Account. The July 23, 2010 Order specifies that Debtor must provide such documents and reports to any creditor who has made a written request. Debtor is also required to maintain separate bank accounts for the Reserve Account and the Rents Account.
On July 15, 2010, CGS filed a status conference statement. According to CGS, Debtor's July 2010 payment to CGS in the amount of $13,274.05 failed to comply with the parties' agreement. Based thereon, the Court set an evidentiary hearing to determine Debtor's compliance with the Plan.
Mr. Goodsell considered what it would cost to hire the equivalent of a trustee to manage the property each year and concluded that it would cost approximately $2,500 per month, or $30,000 per year. Tr. 256:22-25; Tr. 257:1-17. However, no specific evidence was offered on the actual cost of appointing any particular receiver or other person.
There is no evidence that Debtor failed to comply with the parties' agreement, or the July 23, 2010 Order, after July 2010.
II. Conclusions of Law
There can be no serious dispute that, prior to the parties' stipulation as to the calculation of "net proceeds" under the Plan, Debtor did not make the required distributions to the general unsecured creditors. Whether Debtor is correct in its assertion that the calculation of net proceeds should have been on a "balance sheet cash balance" basis, or whether CGS and Tilem are correct in their assertion that the calculation should have excluded unpresented checks, is not an issue the Court needs to decide, partly because of the stipulation and the July 23, 2010 Order, but also for several additional reasons.
Even if Debtor were correct about how the calculation was to be made, Debtor failed to allocate 80% of the net proceeds under a "balance sheet cash balance" analysis to the general unsecured creditors. Using the parties' stipulated figures, Debtor's payments to CGS between December 2007 and June 2010 were short by more than $200,000.00.
Debtor's decision to use proceeds allocable to general unsecured creditors in order to purchase UPS Charlie and UPS David violated the Plan. These sizable purchases were made to expand Debtor's business to bring in new customers. Admittedly, UPS Charlie was profitable and paid for itself. UPS David might well have done the same, but Debtor did not complete construction on UPS David after being told by CGS to cease further construction. Profitability of a plan violation, however, is not the test.
Debtor's violation of the Plan was flagrant. The evidence unequivocally shows that Debtor completely disregarded its obligations under the Plan. After the Plan was confirmed, Debtor assigned all financial tasks to Ms. Rubio, who never read the Plan fully and simply glanced at it. Debtor also never shared a copy of the Plan with Debtor's accountants. In short, Debtor failed to take Debtor's Plan obligations seriously.
CGS and Tilem's closing briefs state that neither seeks a monetary award. CGS and Tilem ask this Court to appoint a receiver to manage Debtor's business operations going forward, or alternatively, to convert the bankruptcy case to Chapter 7. Tilem specifically requests appointment of Randy Sugarman to serve as receiver. Although CGS previously sought appointment of a trustee, CGS now acknowledges that it is no longer possible to appoint a trustee under Chapter 11, but asserts that the Court has authority under California law to appoint a trustee because the Plan can be treated as a final judgment under Fed.R.Civ.P. 69(a).
Debtor contends that neither remedy is appropriate within the context of this case. Debtor asserts that the remedies available to CGS and Tilem include suing Debtor for breach of contract, bringing an adversary proceeding to compel compliance with the Plan, or seeking conversion or dismissal of the bankruptcy case. Debtor argues that the Plan cannot be treated as a final judgment, that appointment of a receiver is not appropriate, and that neither CGS nor Tilem has presented a carefully drafted proposal for appointment of a receiver. Debtor also opposes conversion.
The parties are in agreement that conversion to Chapter 7 is an available remedy expressly contemplated in the Plan and under 11 U.S.C. § 1112 (b). However, none of the parties prefers this remedy. At the hearing, the Court remarked to the parties that this case did not appear to be a Chapter 7 case. Debtor's tax returns through 2009 indicate that Debtor is profitable; the only issue seemed to be whether Debtor has been making the required distributions.
The question, then, is what other remedies exist. In Murdock v. Holquin, 323 B.R. 275, 282-83 (N.D. Cal. 2005) (Judge Ware), the district court stated that when a reorganized debtor defaults under the terms of a confirmed Chapter 11 plan, the creditors entitled to payment under the plan may assert an action for breach of contract in an appropriate court, or may request conversion of the case to Chapter 7 if there has been a "material default." The district court did not offer any alternative choices, but also did not purport to offer a conclusive list of options.
That confirmed Chapter 11 plans are viewed through a contractual lens was also the import of Miller v. United States, 363 F.3d 999 (9th Cir. 2004). In considering whether a tax debt was discharged under the plan, the appellate court observed that "[a] Chapter 11 bankruptcy plan is essentially a contract between the debtor and his creditors, and must be interpreted according to the rules governing the interpretation of contracts." Id. at 1004. Interestingly, because the contract was ambiguous, the appellate court construed the ambiguous terms against the drafter - the debtor - "based on the interpretive principle that ambiguous contractual provisions are to be construed against their drafter." Id. at 1005-06. This is interesting because the drafter in the case at bar was not Debtor, but instead was Debtor's counsel. The argument could therefore be made that any ambiguity in the term "net proceeds" should be construed against CGS, the drafter of this disputed term.
However, it is not necessary for the Court to address the propriety of the remaining remedies sought by CGS and Tilem. Under the Plan, this Court has retained the authority to enforce and implement the Plan, and to enter orders "in aid of consummation" of the Plan. Under the unique circumstances of this case, the Court concludes that certain safeguards need to be put in place in order to ensure that Debtor complies with Debtor's obligations under the Plan.
Under 11 U.S.C. § 1107(a), a debtor-in-possession has certain rights and responsibilities. After confirmation of a plan, a debtor-in-possession shall "file such reports as are necessary or as the court orders[.]" 11 U.S.C. § 1106(a)(7). Here, because of the ambiguity in the Plan as to how payments should be calculated, Debtor has agreed to make payments in accordance with a stipulated methodology. The July 23, 2010 Order binds the parties to this methodology and already imposes a reporting requirement on Debtor. As stated earlier, the July 23, 2010 Order requires Debtor to prepare quarterly balance sheets which distinguish between prepaid rents, the 20% placed into reserve, and the 80% allocated to the creditors. Debtor also must provide quarterly profit and loss reports, quarterly balance sheets, and check registers, as well as a list of tenants and prepaid rents. All of these reports are necessary to allow creditors to verify that Debtor is complying with the Plan, as clarified by the July 23, 2010 Order.
It is apparent that CGS and Tilem do not trust Debtor to apply the stipulated methodology correctly, and with good reason. Debtor's repeated violations of the Plan prior to entry of the stipulation, Ms. Rubio's lack of accounting expertise, Ms. Rubio's failure to understand the requirements of the Plan, and Debtor's failure to inform Debtor's accountants about the Plan's requirements undoubtedly led to this loss of confidence. In addition, CGS has offered evidence that Debtor paid CGS no more than $20,000.00 between May 2010 and November 2011 - an undeniably small sum compared with Debtor's prior payments. The diminished payments to CGS could be explained by the loss of Verio and NTTA as tenants in May 2010. Importantly, the record is devoid of evidence showing that Debtor has incorrectly applied the stipulated methodology after July 2010.
Nevertheless, in light of Debtor's past Plan violations, caused largely by Mr. Rubio's lack of diligence in complying with the Plan and Ms. Rubio's lack of accounting sophistication and failure to understand the Plan's requirements, a prospective order compelling Debtor to make Plan payments is appropriate. From the date of this Order onward, Debtor shall make all payments required by the Plan in the manner clarified by the July 23, 2010 Order.
To aid consummation of the Plan, the Court orders that Debtor shall employ, at Debtor's expense, a certified public accountant to ensure that Debtor's business operations and expenditures comply with the Plan and with the July 23, 2010 Order. Such accountant shall prepare and certify all of the quarterly reports required by the July 23, 2010 Order, as being in compliance with the Plan and such Order, and shall make and certify the required disclosures which Debtor stipulated to make. The accountant shall also audit Debtor's balance sheet and the accounting tasks performed by Ms. Rubio or anyone else on behalf of Debtor, and shall certify that accounting and distributions are, in the accountant's professional opinion, in compliance with the Plan and the July 23, 2010 Order. If, in the accountant's judgment, the accounting and other financial work performed by Debtor (either through Ms. Rubio or anyone else) is unreliable, the accountant shall prepare a written explanation as to what is unreliable and why it is unreliable, shall provide the written explanation to Debtor and any creditors who requested written reports under the terms of the July 23, 2010 Order, and shall do the calculations him or herself. Debtor shall cooperate fully and at all times with the accountant(s).
Debtor may employ any qualified, certified public accountant to perform these duties, including the accountants whom Debtor has employed to prepare tax returns.
The Court has not ruled out the possibility that a receiver or trustee may be appointed. See Silverman v. Tracar, S.A. (In re American Preferred Prescription, Inc.), 255 F.3d 87 (2d Cir. 2001) (the bankruptcy court appointed a Chapter 11 trustee post-confirmation; the district court found this was improper because the plan did not allow such appointment, but the appeals court reversed the district court's decision on other grounds). The Court also has not ruled out the possibility of converting this case to Chapter 7 if Debtor should fail to comply with this Order or with the July 23, 2010 Order, or if Debtor should fail to make any required Plan payments in the future.
IT IS SO ORDERED.