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In Re Walden Ridge Development, LLC

292 B.R. 58 (D. N.J. 2003)

BANKRUPTCY; BAD FAITH—Using an single asset, single purpose entity to contract for a property purchase is a routine way to acquire and develop property and does not lend credence to a claim that a bankrupt debtor acted in bad faith when structuring its transaction before filing.

A limited liability company was formed for the purpose of acquiring and developing a specific parcel of real property. Its managing sole member was an individual. It entered into a contract to purchase property, gave a deposit against the contract, and incurred unsecured debts in connection with the real estate project. It then obtained all of its approvals to build townhouses. By reason of “failure of the parties to satisfy contingencies within the time perimeters originally contemplated,” the closing date was extended four times. Eventually, the seller made closing time of the essence and the debtor was unable to obtain necessary financing by that time. It filed for Chapter 11 bankruptcy protection the day before the closing date. Two days before, the sole member and manager resigned and assigned his membership interest to an unrelated developer. At the same time, the limited liability company entered into an option agreement with another entity owned by the original sole member. That option agreement required the payment of enough money to pay all of the unsecured creditors of the limited liability company. The company that held the option obtained both financing and equity to enable it to pay all of the creditors of the contract-purchaser and to acquire the property.

The seller sought to dismiss the Chapter 11 proceeding, arguing that it was filed in bad faith. If a creditor can prove a debtor’s lack of good faith, the Chapter 11 filing can be dismissed. “A determination of the debtor’s motive for filing centers on the totality of the circumstances. ... Courts have dismissed as bad faith filings for a variety of reasons, including, but not limited to (1) when a petition is merely filed as a litigation tactic; (2) when the petition was filed solely to frustrate the legitimate efforts of other parties to enforce their rights; (3) when the debtor lacks a valid reorganizational purpose; and (4) when the debtor’s sole motive is to avoid a contract. ... Significantly, dismissals of Chapter 11 cases caused by a debtor’s bad faith routinely show elements of prejudice to one or more creditor classes.” Here, the seller argued that he was prejudiced “due to the uncertainty of the economy and the real estate market, conditions always present.” Although the seller argued that the debtor had no real assets, the Court pointed out that the debtor held a valuable purchase contract and did have general unsecured creditors. It didn’t matter that the debtor was never in business and did not intend to stay in business (since all of its rights were assigned). The seller also tried to show the debtor’s bad faith by pointing to case law that described “a classic ‘new debtor syndrome’ case in which a one-asset entity is created on the eve of foreclosure to isolate the insolvent property and its creditors from other assets held by the original debtor which helped form the basis of the lender-borrower relationship.” The Court thought that the facts in this matter were different under the prior case. The prior case involved a debtor that was “created immediately prior to the filing for the specific purpose of acquiring title and seeking bankruptcy protection.” Here, the debtor held a valuable purchase contract which, “by its terms, permit[ted] assignment to an entity provided [that the original manager and member of the debtor was] principal.” The Court believed this to be a routine assignment clause and the seller had no cause to complain about the assignment. Further, the Court believed that the debtor operated a legitimate business since single asset entities are routinely utilized for real estate acquisition and development. “Anything different would be an unusual business practice.” It didn’t matter that the debtor’s business changed because “by the filing it sought to preserve the value of the Property for the benefit of its creditors and [the seller].”


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