Opinion
Case No. 19-19802-JGR Case No. 19-19803-JGR
2020-12-08
IN RE: PEAK SERUM, INC., EIN: 47-2816472 Debtor. In re: Thomas Kutrubes, SSN: xxx-xx-xxxx Debtor.
Aaron A. Garber, Littleton, CO, for Debtor.
Aaron A. Garber, Littleton, CO, for Debtor.
Jointly Administered Under Case No. 19-19802-JGR
ORDER
Joseph G. Rosania, Jr., United States Bankruptcy Judge
Peak Serum, Inc. and Thomas Kutrubes (collectively, the "Debtors") filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code on November 13, 2019, Case Nos. 19-19802-JGR; 19-19803-JGR (collectively, the "Cases"). The Court entered an Order Granting Motion for Joint Administration of the Cases under Case No. 19-19802-JGR on November 18, 2019 (Doc. 38).
PARTIES
Peak Serum, Inc. ("Peak") is a privately owned, independent supplier of life science laboratory products. Peak's core focus is supplying fetal bovine serum for clinical trials and research, and diagnostics applications. Thomas Kutrubes ("Kutrubes") is the owner, president, and CEO of Peak.
Peak is a competitor of Atlas Biologicals, Inc. ("Atlas"). Kutrubes is a former employee and shareholder of Atlas. Atlas is a creditor of both Debtors by virtue of a September 23, 2019 judgment issued jointly and severally against the Debtors in the United States District Court for the District of Colorado, Case No. 15-cv-00355-CMA-KMT, in the amount of $2,048,180.50 (the "Judgment"). The Judgment was issued based upon Atlas's claims against Peak and Kutrubes for federal trademark infringement, Colorado common law trademark and trade name infringement, misappropriation of trade secrets, and breach of fiduciary duty. The Judgment is currently on appeal in the Tenth Circuit Court of Appeals, Case No. 19-1404. The Debtors and Atlas agree that the Judgment prompted the filing of the bankruptcy petitions in these Cases.
Biowest, LLC ("Biowest") is a competitor of Atlas and supplier of fetal bovine serum to Peak. In addition to being a creditor of Peak, Biowest is also a party-in-interest in the Cases pursuant to a purported stock transfer by Kutrubes to Biowest of all of his stock in Atlas in exchange for a shipment of fetal bovine serum. Whether the purported stock transfer was valid is in dispute, and the ownership of the stock is the subject of certain pre-petition litigation which is currently pending before the District Court, Case No. 18-cv-00969-CMA-MEH (the "Stock Ownership Suit"). Biowest supports the Debtors in the matters now before this Court.
PROCEDURAL HISTORY
On March 4, 2020, Atlas moved in both Cases to appoint a Chapter 11 trustee under 11 U.S.C. § 1104(a)(1) or, in the alternative, under 11 U.S.C. § 1104(a)(2) (Case No. 19-19802, Doc. 135; Case No. 19-19803, Doc. 92) (collectively, the "Trustee Motions"). The Debtors objected on March 24, 2020 (Case No. 19-19802, Doc. 149; Case No. 19-190803, Doc. 97). On March 25, 2020, Biowest joined in Kutrubes's objection (Case No. 19-190803, Doc. 98). On April 2, 2020, Peak filed a supplement to its objection (Case No. 19-19802, Doc. 151).
Thereafter, on April 28, 2020, the Debtors filed a Motion to Convert Cases to Sub-Chapter V Cases or in the Alternative to Allow Dismissal and Refiling of Cases (Case No. 19-19802, Doc. 161) (the "Subchapter V Motion"), and a Supplemental Brief in Support on May 26, 2020 (Doc. 190). The United States Trustee and Atlas objected on May 11, 2020 (Doc. 174), and May 12, 2020 (Doc. 175), respectively.
The Court held an evidentiary hearing on both matters on June 10, 11, 16, 18, and 24, 2020, at which it admitted more than one hundred exhibits into evidence; heard testimony of six witnesses—Kutrubes; Rick Paniccia, the owner and president of Atlas; Michelle Cheever, the director of operations and quality assurance at Atlas; Jim DeOlden, the Debtors' rebuttal witness; Mark Dennis, the Debtors' accountant; and Suresh Daniel, the Debtors' expert witness—received an offer of proof from Biowest regarding the proposed testimony of Wendell Leinweber, the president and CEO of Biowest (Doc. 228); and heard legal argument of the parties.
At the evidentiary hearing, the Court noted that the Debtors' eligibility to proceed under Subchapter V is a threshold issue because, if the Debtors were to proceed under Subchapter V, Atlas's request to appoint a trustee would be moot. Accordingly, the Debtors first presented their case on the Subchapter V Motion, after which Atlas presented its case on the Trustee Motions. At the close of the hearing, the Court took the matters under advisement.
Unlike in a standard Chapter 11 case—where 11 U.S.C. § 1104(a) provides that a Chapter 11 trustee may only be appointed for "cause" or "if such appointment is in the interests of creditors, equity security holders, and other interests in the estate"—appointment of a trustee is automatic in a case under Subchapter V. While a Subchapter V trustee does not necessarily perform the duties of a Chapter 11 trustee, where cause would exist to appoint a Chapter 11 trustee in a standard Chapter 11 case, Subchapter V affords parties-in-interest comparable remedies, including removal of the debtor-in-possession and expansion of the Subchapter V trustee's duties. See 11 U.S.C. §§ 1185(a) and 1183(b).
The Court has jurisdiction over these contested matters pursuant to 28 U.S.C. §§ 157(b)(1), 157(b)(2)(A), and 1334.
DEBTORS' SUBCHAPTER V ELIGIBILITY
The Small Business Reorganization Act of 2019 ("SBRA") was enacted prior to the filing of the Cases on August 23, 2019. See Pub. L. No. 116-54, 133 Stat. 1079 (2019). Pursuant to § 5, the effective date of SBRA was February 19, 2020—approximately three months after the Cases were filed. See § 5, 133 Stat. 1079, 1087. SBRA authorizes small business debtors to proceed under the new provisions of Subchapter V of Chapter 11 of the Bankruptcy Code. To qualify as a small business debtor under SBRA, a debtor must have aggregate, noncontingent, liquidated, secured and unsecured debts, as of the date of the filing of the petition or the order for relief, in an amount not more than $2,725,625. See § 2, 133 Stat. 1079; 11 U.S.C. §§ 101(51D) and 104.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") was enacted, which, in relevant part, amends SBRA. See Pub. L. No. 116-136 § 1113, 134 Stat 281. Specifically, § 1113 of the CARES Act temporarily increases the debt limit to qualify as a debtor under SBRA to $7.5 million. However, § 1113(a)(3) of the CARES Act expressly states that the increased debt limit "shall apply only with respect to cases commenced under title 11, United States Code, on or after the date of enactment of this Act ." § 1113(a)(3), 134 Stat 281, 311 (emphasis added).
I. Facts
The following facts pertinent to the Subchapter V Motion are undisputed.
On page 2, line 8 of its petition, Peak did not check that either of the following applied:
• Debtor's aggregate noncontingent liquidated debts (excluding debts owed to insiders or affiliates) are less than $2,725,625; or
• The debtor is a small business debtor as defined in 11 U.S.C. § 101(51D)
(UST's Ex. II). Peak's Schedules D and E/F, filed contemporaneously with its petition on November 13, 2019, reflected aggregate secured and unsecured debts in the amount of $3,580,644.67 (Id. ). Peak did not mark any of its debts as contingent, unliquidated, or disputed (Id. ). Peak amended its Schedule E/F on January 14, 2020, to increase the amount of its unsecured debt by $8,000, for aggregate secured and unsecured debts in the amount of $3,588,644.67 (UST's Ex. IV). Peak did not mark any of the debts on its Amended Schedule E/F as contingent, unliquidated, or disputed (Id. ).
On page 4, line 13 of his petition, Kutrubes checked: "I am filing under Chapter 11, but I am NOT a small business debtor according to the definition in the Bankruptcy Code" (UST's Ex. III). Kutrubes's Schedules D and E/F, filed contemporaneously with his petition on November 13, 2019, reflect aggregate secured and unsecured debts in the amount of $3,326,778.97 (Id. ). Kutrubes did not mark any of his debts as contingent, unliquidated, or disputed (Id. ).
The Debtors do not dispute that, as of the filing of the Cases, their aggregate, noncontingent, liquidated debts exceeded the $2,725,625 debt limit to qualify as a small business debtor under SBRA. Moreover, the Debtors concede that the "CARES Act provides that the increased debt limit applies only to cases filed after its enactment" (Doc. Atlas's Ex. 41, ¶ 14). Nonetheless, the Debtors seek authority from this Court to proceed under Subchapter V because "[t]he CARES Act was designed, among other things, to save small businesses such as Peak" that are impacted by the COVID-19 pandemic (Id. at ¶ 21). The Debtors argue that, in addition to reducing estate expenses, proceeding under Subchapter V would promote efficiency in the bankruptcy process and provide for oversight of the Debtors by a trustee to satisfy, to some extent, Atlas's request for appointment of a Chapter 11 trustee.
The United States Trustee and Atlas argue that § 1113(a)(3) of the CARES Act expressly states that it applies only to cases filed on or after the date the CARES Act was enacted. Because the Cases were filed more than four months prior to the enactment of the CARES Act, the United States Trustee and Atlas contend that the increased debt limit provided for by the CARES Act does not apply to the Cases. Thus, the United States Trustee and Atlas agree that because the Debtors' aggregate, noncontingent, liquidated debts exceeded the $2,725,625 debt limit set forth in 11 U.S.C. § 101(51D) to qualify as small business debtors under SBRA on the date the Cases were filed, the Debtors are not eligible to proceed under Subchapter V. Atlas also argues that the Debtors are ineligible to proceed under Subchapter V because they are incapable of complying with certain statutory deadlines imposed on all Subchapter V debtors, including that debtors must file a plan within 90 days of the petition date and the Court must hold a status conference within 60 days of the petition date, as those deadlines have passed. The Court notes that 11 U.S.C. §§ 1188(b) and 1189(b) provide for the extension of such deadlines "if the need for an extension is attributable to circumstances for which the debtor should not justly be held accountable," and most courts that have considered these deadlines in cases of retroactive election to proceed under Subchapter V have found that they may be extended. See In re Ventura , 615 B.R. 1 (Bankr. E.D.N.Y. 2020) ; In re Trepetin , 617 B.R. 841 (Bankr. D. Md. 2020) ; In re Twin Pines, LLC , Case No. 19-10295-j11, 2020 WL 5576957, 2020 Bankr. LEXIS 1217 (Bankr. D. N.M. Apr. 30, 2020) ; but see In re Seven Stars on the Hudson Corp. , 618 B.R. 333 (Bankr. S.D. Fla. 2020).
Atlas further argues that the doctrine of judicial estoppel bars the Debtors from amending their petitions "to transform themselves into ‘small business debtors’ eligible for Subchapter V relief" (Doc. 24, ¶ 30). Atlas asserts that to hold otherwise would reward the Debtors' gamesmanship and "thinly-veiled effort to take advantage of a law change (not intended to benefit [them] ) retroactively, after all parties have relied upon these proceedings, and have allowed these cases to advance for over six months based upon existing law, case events and the [C]hapter 11 rules which have guided them and the Court, and while the [Trustee Motions are] pending" (Id. ).
Finally, Atlas makes additional arguments against conversion, including (i) the Debtors do not have an absolute right to convert their Cases to Subchapter V, and their bad-faith conduct is a factor that the Court should consider in determining whether the Cases should be converted, citing Marrama v. Citizens Bank of Massachusetts , 549 U.S. 365, 127 S.Ct. 1105, 166 L.Ed.2d 956 (2007) ; and (ii) conversion would be a futile and wasted act when the Trustee Motions are pending, citing 11 U.S.C. §§ 1112(b) and 706(b). However, these arguments are misplaced. "Conversion" is a misnomer where, as here, the Debtors do not seek to convert the Cases to cases under another chapter of the Bankruptcy Code but, rather, seek authority to remain in Chapter 11 and amend their petitions to elect to proceed under Subchapter V. See e.g. , Seven Stars on the Hudson Corp. , 618 B.R. at 342 n.58 ("[A] debtor elects to proceed under Subchapter V by amending its petition – as opposed to converting its case from one chapter of the Bankruptcy Code to another chapter....").
II. Analysis
The Court notes that "there is no statutory prohibition to applying ... SBRA to cases that were pending prior to the effective date of this legislation." In re Ventura , 615 B.R. 1, 15 (Bankr. E.D.N.Y. 2020). Thus, an eligible pre-SBRA debtor may generally amend its petition to elect to proceed under Subchapter V, subject to providing notice and an opportunity to object to all parties-in-interest under Fed. R. Bankr. P. 1009(a) and 1020(b) and, in the event of an objection to such election, a finding that the level of prejudice to the objecting party does not override the debtor's right to amend its petition under Rule 1009(a). See In re Body Transit, Inc. , 613 B.R. 400, 410 (Bankr. E.D. Pa. 2020).
At issue in these Cases, however, is whether the increased debt limit to qualify as a debtor under SBRA provided for by the CARES Act applies retroactively to bankruptcy cases filed prior to the CARES Act's enactment, such that a debtor whose aggregate, noncontingent, liquidated debts exceeded $2,725,625 on the date of filing may be eligible for Subchapter V relief. This is an issue of first impression.
One bankruptcy court has implied that the CARES Act's increased debt limit applies to cases filed prior to its enactment, but the implication was not accompanied by legal analysis or conclusions. See In re Bonert , 619 B.R. 248, 257 (Bankr. C.D. Cal. 2020).
The answer hinges on the statutory interpretation of the CARES Act. "Statutory construction must begin with the language employed by Congress and the assumption that the ordinary meaning of that language accurately expresses the legislative purpose." Taylor v. Taylor (In re Taylor) , 737 F.3d 670, 678 (10th Cir. 2013) (quoting Park ‘N Fly, Inc. v. Dollar Park & Fly, Inc. , 469 U.S. 189, 194, 105 S.Ct. 658, 83 L.Ed.2d 582 (1985) ). "When the words of a statute are unambiguous, then, this first canon is also the last: judicial inquiry is complete." Wadsworth v. The Word of Life Christian Ctr. (In re McGough) , 737 F.3d 1268, 1273 (10th Cir. 2013) (quoting Connecticut Nat. Bank v. Germain , 503 U.S. 249, 254, 112 S.Ct. 1146, 117 L.Ed.2d 391 (1992) ).
Here, the Court finds that the language of the CARES Act is unambiguous. To wit, § 1113(a)(3) of the CARES Act expressly states that the increased debt limit "shall apply only with respect to cases commenced under title 11, United States Code, on or after the date of enactment of this Act ." That the Debtors may have been impacted by the COVID-19 pandemic post-petition is irrelevant where the Cases were filed prior to the enactment of the CARES Act. Accordingly, because the Debtors' aggregate, noncontingent, liquidated debts exceeded the $2,725,625 debt limit set forth in 11 U.S.C. § 101(51D) to qualify as small business debtors under SBRA on the date the Cases were filed, the Debtors are not eligible to proceed under Subchapter V.
Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA"), a Chapter 11 debtor elected whether to proceed as a small business debtor and incur the burdens and benefits associated with such an election. In re Roots Rents, Inc. , 420 B.R. 28, 34 (Bankr. D. Idaho 2009) (citing 11 U.S.C. § 1121(e) (2004) (establishing certain deadlines "[i]n a case in which the debtor is a small business and elects to be considered a small business [.]") (emphasis added)). BAPCPA eliminated any "election" by the debtor by amending former 11 U.S.C. § 101(51C) and incorporating the term "small business debtor" into the definition of "small business case." Id. (citing 11 U.S.C. § 101(51C) ).
In relevant part, 11 U.S.C. § 101(51D) defines a "small business debtor" as:
(A) ... a person engaged in commercial or business activities (including any affiliate of such person that is also a debtor under this title and excluding a person whose primary activity is the business of owning single asset real estate) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition or the date of the order for relief in an amount not more than $2,725,625 (excluding debts owed to 1 or more affiliates or insiders) not less than 50 percent of which arose from the commercial or business activities of the debtor ....
Simply put, post-BAPCPA, a debtor either meets the statutory definition of a small business debtor, or it does not. Here, the Debtors do not. Peak's Schedule D and Amended Schedule E/F reflect aggregate, noncontingent, liquidated debts in the amount of $3,588,644.67, and Kutrubes's Schedules D and E/F reflect aggregate, noncontingent, liquidated debts in the amount of $3,326,778.97. The Court cannot circumvent the $2,725,625 debt limit contained in 11 U.S.C. § 101(51D) to permit the Debtors to qualify as small business debtors under SBRA and proceed under Subchapter V.
Because the Court finds that the Debtors are ineligible to proceed under Subchapter V, the Court need not reach Atlas's judicial estoppel argument, nor determine whether the deadlines imposed by 11 U.S.C. §§ 1188 and 1189 may be extended based upon the facts of the Cases.
The Court will now weigh the Debtors' request for dismissal of the Cases against Atlas's request for appointment of a Chapter 11 trustee.
DISMISSAL v. APPOINTMENT OF TRUSTEE
The Debtors request that if they are not permitted to proceed under Subchapter V, the Court dismiss the Cases so that they may be refiled as Subchapter V cases. With respect to Kutrubes's case, the Debtors seek a preemptive finding by the Court that Kutrubes's refiled case will be a good-faith filing.
Under 11 U.S.C. § 362(c)(3)(A), as an individual, if Kutrubes were to file another Chapter 11 case after the dismissal of his present case, the automatic stay afforded under 11 U.S.C. § 362(a) would terminate with respect to Kutrubes on the 30th day after the filing of the later case. However, 11 U.S.C. § 362(c)(3)(B) provides a mechanism to extend the automatic stay in the later case if Kutrubes "demonstrates that the filing of the later case is in good faith as to the creditors to be stayed." While the Debtors acknowledge that Kutrubes would need to comply with 11 U.S.C. § 362(c)(3)(B) in his refiled case, they seek a determination in his present case that the dismissal of his case to refile under Subchapter V is sought in good faith.
Atlas argues that the Debtors do not have an absolute right to dismiss their Cases, and that they have not established cause for dismissal. Atlas also asserts that creditors would be prejudiced if the Debtors were permitted to dismiss the Cases to refile under Subchapter V. Specifically, Atlas contends that it would "adversely affect the Estate's ability to assert potential [C]hapter 5 avoidance actions, as the date of the Debtors' respective orders for relief would change, depriving the Estates of the right to pursue such claims and insulating potential recipients of preferences or other avoidable transfers from recovery..." (Atlas's Ex. 34, ¶ 25). Instead, Atlas argues that because it has no faith or confidence in the Debtors' ability to be honest and successfully reorganize, the Court should appoint a Chapter 11 trustee in the Cases.
As a preliminary matter, the Court informed the parties at the evidentiary hearing that it believes the Debtors' request for a preemptive finding that Kutrubes's refiled case will be a good-faith filing, amounts to a request for an advisory opinion. "A federal court may not issue advisory opinions based on hypothetical facts." In re Martino , No. 11-31115 MER, 2012 WL 1439091, at *4 (Bankr. D. Colo. Apr. 26, 2012) (citing Flast v. Cohen , 392 U.S. 83, 96, 88 S.Ct. 1942, 20 L.Ed.2d 947 (1968) ). Accordingly, in the event the Court determines that Kutrubes's case should be dismissed, the Court declines to issue an advisory opinion regarding a hypothetical case refiled by Kutrubes in the future. Any determination that a future case is refiled in good faith must be made in the refiled case. I. Legal Standards
A. Dismissal
Dismissal or conversion under 11 U.S.C. § 1112(b) is a two-step process. In re OptInRealBig.com, LLC , 345 B.R. 277, 282 (Bankr. D. Colo. 2006) (citation omitted). "First, the Court must determine if ‘cause’ exists for dismissal or conversion of the [C]hapter 11 case." Id. "Next, the Court must determine whether dismissal or conversion of the case is in the best interest of creditors and the estate." Id. While 11 U.S.C. § 1112(b)(4) contains a non-exhaustive list of sixteen examples of cause to convert or dismiss a case, courts may find cause for other equitable reasons. In re Whetten , 473 B.R. 380, 382 (Bankr. D. Colo. 2012). "The movant bears the burden of establishing cause by a preponderance of the evidence." Id. (citation omitted).
Because many of the examples enumerated in 11 U.S.C. § 1112(b)(4) may not apply when a Chapter 11 debtor seeks voluntary dismissal, some courts have focused upon factors such as whether a valid purpose of Chapter 11 no longer exists or can be better achieved outside the Chapter 11 context:
For example, because of postpetition actions there may no longer be any business to reorganize, or there may be a lack of assets to administer, in [C]hapter 11; there may have been a material change in circumstances postpetition such that confirmation of a [C]hapter 11 plan is no longer possible; the legitimate purpose intended by the debtor's [C]hapter 11 bankruptcy filing may have been achieved through settlement of litigation; or all interested parties may agree that continuation of the [C]hapter 11 case is not in their respective best interests.
In re Brewery Park Assocs., L.P. , No. BR 10-11555, 2011 WL 1980289, at *16 (Bankr. E.D. Pa. Apr. 29, 2011) (citations omitted).
However, a Chapter 11 debtor's preference for dismissal is not dispositive. SWJ Mgmt., LLC v. Coan , 551 B.R. 93, 98 (D. Conn. 2015). Indeed, a Chapter 11 debtor does not have an absolute right to dismiss its case. See e.g. , In re Just Plumbing & Heating Supply, Inc. , No. 11-10151 MG, 2011 WL 4962993, at *2 (Bankr. S.D.N.Y. Oct. 18, 2011) ("Unlike [C]hapter 12 and 13 debtors, a Chapter 11 debtor does not enjoy an absolute right to a dismissal of its bankruptcy.") (internal quotation marks and citation omitted). "While a [Chapter 11] debtor may voluntarily choose to place [itself] in bankruptcy, [it] does not enjoy the same discretion to withdraw [its] case once it has been commenced." In re Sanders , 417 B.R. 596, 602 (D. Ariz. 2009) (citation and internal quotation marks omitted). "If dismissal will prejudice interested parties, a court may refuse to allow a debtor to dismiss the petition." Id. (citation omitted).
Where a Chapter 11 debtor satisfies both prongs of 11 U.S.C. § 1112(b) on a voluntary motion to dismiss, the court shall dismiss the case, "unless the court determines that the appointment under section 1104(a) of a trustee or an examiner is in the best interests of creditors and the estate." See 11 U.S.C. § 1112(b)(1).
B. Appointment of a Chapter 11 trustee
11 U.S.C. § 1104 provides as follows:
(a) At any time after the commencement of the case but before confirmation of a plan, on request of a party in interest or the United States trustee, and after notice and a hearing, the court shall order the appointment of a trustee
(1) for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case, or similar cause, but not including the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor; or
(2) if such appointment is in the interests of creditors, any equity security holders, and other interests of the estate, without regard to the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor.
The first subsection of 11 U.S.C. § 1104(a) provides for the appointment of a trustee for "cause," including, but not limited to, "fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case."
Under the second subsection of 11 U.S.C. § 1104(a), "[t]he court is vested with even broader discretionary powers ... and may consider equitable factors to determine whether a trustee is in the interests of the estate and its creditors." In re Celeritas Techs., LLC , 446 B.R. 514, 518 (Bankr. D. Kan. 2011). Such equitable factors include:
(i) the trustworthiness of the debtor;
(ii) the debtor in possession's past and present performance and prospects for the debtor's rehabilitation;
(iii) the confidence—or lack thereof—of the business community and of creditors in present management;
(iv) the benefits derived by the appointment of a trustee, balanced against the costs of appointment.
In re Colorado-Ute Elec. Ass'n, Inc. , 120 B.R. 164, 176 (Bankr. D. Colo. 1990) (citation omitted).
Courts have found that a Chapter 11 trustee should be appointed when there "is either a perceived dishonesty or withholding of information or a debtor's inability to provide accurate records and reports":
"One of the most fundamental and crucial duties of a debtor-in-possession upon the filing of a Chapter 11 petition is to keep the Court and creditors informed about the nature, status and condition of the business undergoing reorganization." Savino, 99 B.R. at 526. Consequently, "[w]here ... the Debtor fails to disclose material and relevant information to the Court and creditors, a Chapter 11 trustee is required." Id. ; see In re Oklahoma Refining Co., 838 F.2d 1133, 1136 (10th Cir.1988) ("It is also established that failure to keep adequate records and make prompt and complete reports justifies the appointment of a trustee."); [In re ] Ford, 36 B.R. [501] at 504 [ (Bankr.D.Ky.1983) ] ("Inherent in debtor's fiduciary obligations under the Code is the duty to file accurate financial reports disclosing all transactions involving estate assets.... Any failure to file accurate financial statements is an omission contributing to cause for appointment of a trustee.") ....
Plaza de Retiro, Inc. , 417 B.R. 632, 641 (Bankr. D.N.M. 2009) (quoting Tradex Corp. v. Morse , 339 B.R. 823, 833 (D. Mass. 2006) ).
Courts have also found that appointment of a Chapter 11 trustee is appropriate when "acrimony between a debtor-in-possession's management and the creditors ... impedes the reorganization effort." Id. at 640–41 (collecting cases). Indeed, where a debtor and its principal creditor are in deadlock, this fact counsels in favor of appointing a neutral manager, such as a Chapter 11 trustee, to run the business. In re SI Grand Traverse LLC , 450 B.R. 703, 710 (Bankr. W.D. Mich. 2011).
"[O]nce a bankruptcy court determines that cause exists for appointment of a trustee under section 1104(a)(1) or that appointment of a trustee would be in the best interest of creditors under section 1104(a)(2), it has no discretion but must appoint a trustee." Sims v. Sims (In re Sims) , 226 B.R. 284 (B.A.P. 10th Cir. 1997) (quoting In re Oklahoma Ref. Co. , 838 F.2d 1133, 1136 (10th Cir. 1988) ) (internal quotation marks omitted).
The movant bears the burden of establishing that a Chapter 11 trustee should be appointed, but courts are split regarding the standard of proof the movant must meet. The majority of courts hold that the movant must meet this burden by a clear and convincing standard of proof. See In re Bayou Grp., LLC , 564 F.3d 541, 546 (2d Cir. 2009) ; In re G-I Holdings, Inc. , 385 F.3d 313, 318 (3d Cir. 2004). Whereas, a minority of courts hold that the standard of proof is a preponderance of the evidence. See In re Keeley & Grabanski Land P'ship , 455 B.R. 153, 163 (B.A.P. 8th Cir. 2011). While the Tenth Circuit has not ruled on the issue, it would likely adopt a preponderance of the evidence standard. In re Golden Park Estates, LLC , No. 14-12253 T11, 2015 WL 3643479, at *5 (Bankr. D.N.M. June 11, 2015) ; see also Celeritas Techs. , 446 B.R. at 519 (analyzing Tradex Corp. , 339 B.R. at 829–30 ) (rejecting a clear and convincing standard and adopting a preponderance of evidence standard for appointment of a Chapter 11 trustee based upon the Supreme Court's reasoning in Grogan v. Garner , 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991) ).
Appointment of a trustee in a Chapter 11 case is an extraordinary remedy because it strips a debtor of the rights, powers, and duties of a debtor-in-possession. In re Railyard Co., LLC , No. 15-12386-J11, 2016 WL 1254998, at *10 (Bankr. D.N.M. Mar. 30, 2016). "There is a strong presumption that the debtor should be permitted to remain in possession absent a showing of need for the appointment of a trustee." In re Ionosphere Clubs, Inc. , 113 B.R. 164, 167 (Bankr. S.D.N.Y. 1990) (citations omitted). However, 11 U.S.C. § 1104 "represents a potentially important protection that courts should not lightly disregard or encumber with overly protective attitudes towards debtors-in-possession." In re V. Savino Oil & Heating Co., Inc. , 99 B.R. 518, 525 (Bankr. E.D.N.Y. 1989).
Ultimately, the decision to appoint a trustee is fact intensive and must be made on a case-by-case basis. Plaza de Retiro, Inc. , 417 B.R. at 640 (citation omitted). "The Court's task is to determine whether the totality of the circumstances warrant appointment of a trustee." Id.
II. Facts
Atlas argues that the following facts support appointment of a Chapter 11 trustee in the Cases:
A. Dishonesty
The actions taken by Kutrubes in the formation of Peak prompted a four-year long legal action in the United States District Court for the District of Colorado, which culminated in a five-day bench trial and a fifty-six-page opinion and Judgment in favor of Atlas and against Kutrubes and Peak for federal trademark infringement, Colorado common law trademark and trade name infringement, misappropriation of trade secrets, and breach of fiduciary duty (Trial Tr. 98:19-25, June 10, 2020) (Atlas's Ex. 3).
Pertinent factual findings from District Court Judge Arguello's opinion include:
Unbeknownst to Atlas, Kutrubes was developing a business plan to compete with Atlas while he was still in Atlas's employ.... Kutrubes "took certain information, documentation, and data" from Atlas by emailing documents from his Atlas-provided email account to his personal Gmail account.... These documents included Atlas's customer contact lists, a supplier agreement; its quality manual; its organizational chart; a contract manufacturing statement; proofs of labels; a marketing brochure; and email exchanges about Atlas's products, among others.... Kutrubes also "sent certain emails to customers of [Atlas]" that contained Atlas's trademarks and trade names and "solicited business for his company, Peak Serum." ... In these emails, Kutrubes falsely represented to Atlas's customers that Atlas and Peak Serum were "sister companies," that Atlas was no longer conducting international business, and that Peak Serum would be assuming Atlas's international customers.... Kutrubes also contacted Atlas's suppliers, contract manufacturers, and business partners ... in attempt to secure product for Peak Serum ...
(Atlas's Ex. 3, pp. 4–5). Kutrubes admitted before this Court to taking the actions set forth above (Trial Tr. 99:5-100:1, June 10, 2020).
B. Breach of fiduciary duty
Kutrubes admitted, before both Judge Arguello and this Court, to breaching his fiduciary duties to Atlas in the formation of Peak (Trial Tr. 98:11-13, 100:2-5, June 10, 2020) (Atlas's Ex. 3, p. 10). As an employee of Atlas, Kutrubes owed Atlas a duty of loyalty (Atlas's Ex. 3, p. 49) (citing Jet Courier Serv., Inc. v. Mulei , 771 P.2d 486, 491–94 (Colo. 1989) ). As a director of Atlas, Kutrubes had a duty to act in good faith and in a manner that he reasonably believed to be in the interests of Atlas and all of its shareholders (Atlas's Ex. 3, p. 50) (citing Colt v. Mt. Princeton Trout Club, Inc. , 78 P.3d 1115, 1119 (Colo. App. 2003) (citing Michaelson v. Michaelson , 939 P.2d 835 (Colo. 1997) ), cert. denied , No. 03SC240, 2003 WL 22472186 (Colo. Nov. 3, 2003) ; River Mgmt. Corp. v. Lodge Prop. Inc. , 829 P.2d 398, 401 (Colo. App. 1981) ).
Pertinent legal conclusions from Judge Arguello's opinion include:
[T]he Court concludes that Kutrubes breached his fiduciary duties to Atlas from October 1, 2014, until he was terminated on December 27, 2014, by making misrepresentations to Atlas's customers and prospective customers about Atlas's product offerings and by soliciting their business on behalf of Peak Serum. Kutrubes concedes that by so doing, he breached his duty of loyalty as an employee .... The Court concludes that this conduct also amounts to a breach of his fiduciary duties as a director; Kutrubes plainly was not acting in good faith ...
(Atlas's Ex. 3, pp. 50–51).
C. Mislabeling of bovine serum
Kutrubes conceded, before both Judge Arguello and this Court, that Peak mislabeled multiple pre-petition lots of bovine serum (Trial Tr. 102:17-23, June 10, 2020; 97:21-98:2, June 11, 2020) (Atlas's Ex. 3, p. 27).
Judge Arguello generally described the bovine serum manufacturing process and the importance of accurate labeling as follows:
When manufacturers collect raw fetal bovine serum, they assign it a lot number, which enables the manufacturer to document all material used to make a particular final product.... According to industry best practices, a lot of serum is a uniform batch of product, and the entire batch is produced by a single manufacturer and on the same day.... Lot numbers are used in the analysis and labelling of serum-based products, and accurate labelling is critically important to consumers of such products because they depend on the product being what it is identified as and on it having a consistent character ...
(Atlas's Ex. 3, p. 25). Kutrubes agreed with Judge Arguello's characterization of the serum manufacturing process (Trial Tr. 95:14-96:6, June 11, 2020).
Elaborating on the purpose of the serum manufacturing process, Michelle Cheever ("Cheever"), director of operations and quality assurance at Atlas, testified that one bottle from a lot of bovine serum is representative of the entire lot:
A ... the whole purpose is to ensure that there's consistency of a lot. A lot is supposed to have been manufactured the same way so that the entire batch that is given a batch number is produced in the same manner so that a customer can expect that that first bottle behaves similarly or the same as the last bottle of that batch that's produced throughout the day.
Q So there should not -- is it true that there should not be a variance from one bottle to another within the same lot?
A It should be minimized
(Trial Tr. 40:12-21, June 16, 2020).
Pre-petition, Judge Arguello concluded that Kutrubes and Peak mislabeled lot 31C141 of fetal bovine serum:
The Court finds that Kutrubes and Peak Serum mislabeled Peak Serum Lot 31C141. On December 17, 2014, Peak Serum acquired 246 500ml bottles of fetal bovine serum, identified as Lot 20140331FS, from Rocky Mountain Biologicals, Inc. ("RMBIO"), one of its contract manufacturers.... Despite buying only 246 bottles of serum from RMBIO, and representing to the USDA that these 246 bottles made up the entirety of Peak Serum Lot 31C141, Peak Serum went on to sell more than 1,036 bottles of serum labeled as Peak Serum lot 31C141.... Peak Serum's own records show that Peak Serum sold more bottles of product labeled as Peak Serum Lot 31C141 than it had purchased from RMBIO.... This is convincing evidence of mislabeling by Kutrubes and Peak Serum. When presented with this evidence, Kutrubes conceded that "there definitely was an error" in Peak Serum's labeling and that "there was more than one lot that was inaccurate[ly]" labelled ...
(Atlas's Ex. 3, pp. 25-27).
Atlas alleges that Peak's mislabeling of bovine serum has continued post-petition. However, rather than "overselling" lots, Atlas asserts that the bovine serum which has been mislabeled post-petition was adulterated.
Cheever testified regarding certain marker levels that are characteristic, specifically, of fetal bovine serum, as opposed to other types of bovine serum. First, Cheever testified that, in fetal bovine serum, the level of immunoglobulin-G ("IgG"), which is responsible for immunity, is inherently low because a fetal bovine which has not yet been born has had no opportunity to increase its IgG level through sources outside the womb (Trial Tr. 22:12-23:1, June 16, 2020). Cheever testified that, per guidelines set by United States Pharmacopeia, the industry standard for the level of IgG in fetal bovine serum is < 500 micrograms per milliliter (Trial Tr. 23:5-15, June 16, 2020). Second, Cheever testified that, in fetal bovine serum, the level of gamma-glutamyl transferase ("GGT") should be < 10 international units per liter (Trial Tr. 28:16-19, June 16, 2020) for similar reasons that the level of IgG is inherently low in a fetal bovine (Trial Tr. 23:24-24:3, June 16, 2020).
On June 30, 2017, Sumagen Canada purchased lot 18K161 of fetal bovine serum from Peak (Debtors' Ex. F). Per the purchase order, lot 18K161, which consisted of 135 bottles of fetal bovine serum manufactured by Peak in August 2016 (Atlas's Exs. 50; 64), was to be delivered to Colorado State University ("CSU") (Debtors' Ex. F). Thereafter, in February 2020, CSU contacted Atlas to test a bottle of fetal bovine serum from lot 18K161 to determine why serum from the lot was not performing as expected (Atlas's Ex. 49). The bottle of serum possessed a tamper-resistant heat shrink seal and was unopened (Trial Tr. 49:19-25, June 16, 2020) (Atlas's Ex. 49). Testing determined that the bottle from lot 18K161 was not, in fact, fetal bovine serum, as the IgG level exceeded the industry standard of < 500 micrograms per milliliter (Trial Tr. 32:2-10, June 16, 2020) (Atlas's Exs. 52-55). At all times that lot 18K161 was tested, the IgG level was at least 840 micrograms per milliliter, and the GGT level was at least 176 international units per liter (Debtors' Ex. E).
This measure has been converted from milligrams per deciliter to micrograms per milliliter for ease of comparison (Trial Tr. 168:3-19, June 11, 2020).
Not only did Kutrubes fail to advise Sumagen that lot 18K161 was not fetal bovine serum (Trial Tr. 36:6-10, June 16, 2020), but he also altered an independent certificate of analysis performed by Omega for lot 18K161 so that it would appear to Sumagen that lot 18K161 was fetal bovine serum (Compare Atlas's Ex. 50, with Atlas's Exs. 51, p.1; 64). Specifically, Peak tendered a certificate of analysis to Sumagen which was altered to reflect that the IgG level in lot 18K161 was only 77 micrograms per milliliter, and not the actual level of 840 micrograms per milliliter (Compare Atlas's Ex. 50, with Atlas's Exs. 51, p.1; 64).
Because fetal bovine serum is the most costly type of bovine serum (Trial Tr. 52:21-53:3, June 16, 2020), Atlas alleges that Peak's failure to recall or refund the adulterated serum creates potential claims against the estate that have not been scheduled in Peak's case and creates exposure for the estate.
D. Inaccurate financial reporting
Kutrubes caused Peak to file erroneous and misleading monthly reports, which he swore under oath were accurate. Kutrubes knew as far back as December 31, 2019, that Peak's November 2019 Monthly Operating Report was inaccurate and had to be amended (Trial Tr. 22:13-20, June 11, 2020) (Atlas's Ex. 22, p. 8). Yet, despite this knowledge, Kutrubes took no steps to advise any party-in-interest of this fact. Instead, Peak continued to file inaccurate reports (Atlas's Exs. 4-9), allowing Atlas, the United States Trustee, the Court, and all other parties to believe that the reports were an accurate reflection of Peak's post-petition business activities. Peak did not amend its Monthly Operating Reports for November 2019 through April 2020 (Debtors' Ex. G) until June 5, 2020.
E. Financial losses
Peak has not met its cash flow projections and appears to be incapable of reorganizing. Peak's initial Monthly Operating Reports for November 2019 through April 2020 (Atlas's Exs. 4-9) and monthly collateral reports required pursuant to the cash collateral stipulation with First National Bank of Omaha (Atlas's Exs. 17-21), reflect massive losses. As of March 31, 2020, Peak's unpaid post-petition accounts payable totaled $973,711.67 (Atlas's Exs. 8; 19). When asked about the amount of Peak's unpaid post-petition accounts payable reported on the March 2020 reports (Atlas's Exs. 8; 19), Mark Dennis, the Debtors' accountant, agreed that it "paints a picture of a Debtor that roughly owes a million dollars in unpaid payables after roughly five months in bankruptcy" (Trial Tr. 88:23-89:9, June 16, 2020).
Even after Peak's Monthly Operating Reports for November 2019 through April 2020 were amended on June 5, 2020, to correct inaccuracies (Debtors' Ex. G), the reports still reflected that Peak lost more than $162,000 between the petition date and April 2020. The May 2020 Monthly Operating Report (Atlas's Ex. 71), filed on June 24, 2020, reflected additional losses, totaling more than $214,000 in the seven months that Peak had been in Chapter 11.
A summary of Peak's cash collateral budget, income projections, and reconciliation (Atlas's Exs. 37; 39) reflect that its losses will continue each month from July 2020 to December 2020, unabated (Trial Tr. 53:25-54:5, June 11, 2020). The amount of the losses estimated by Peak during this period total $1,403,688 (Atlas's Ex. 37).
F. Mexico trip
Kutrubes determined that it was in the best interest of Peak to shut its business down for approximately one week in January 2019 while he took the company employees to Mexico for a teambuilding trip, budgeting the use of approximately $11,000 in cash collateral to do so (Trial Tr. 131:8-132:7, June 10, 2020) (Atlas's Ex. 37). When Atlas challenged this expenditure at the initial hearing regarding Peak's use of cash collateral, Kutrubes advised the Court that he would lose a substantial deposit if the trip were to be cancelled (Trial Tr. 132:8-132:10, June 10, 2020). However, Kutrubes testified at the evidentiary hearing that the deposit was only $500 (Trial Tr. 132:11-132:19, June 10, 2020).
Atlas argues that, while Peak possessed the Court's permission to use cash collateral for this purpose, the Mexico trip reflects poor business judgment by a corporate debtor which cannot pay its debts.
G. Lapsed deadlines
The Debtors' exclusive period within which to file a Chapter 11 plan expired on March 12th, 2020, and no motion to extend the exclusive period was filed prior to such expiration (Trial Tr. 43:14-44:7, June 11, 2020).
Similarly, the Court granted the Debtors an additional ninety days, through June 10, 2020, to seek to assume or reject the commercial real property leases where Peak conducts business. The Debtors failed to file any further pleadings regarding the leases prior to the expiration of the extension.
Atlas argues that, by permitting crucial deadlines in the Cases to lapse, the Debtors have displayed gross mismanagement and incompetence.
H. Delay
The Debtors failed to take any steps post-petition to obtain stay relief to allow the pre-petition litigation with Atlas to proceed, even though final resolution of both lawsuits is required for estate administration purposes. Instead, the Debtors opposed Atlas's motion for relief from stay to allow the Stock Ownership Suit to continue.
Further, at the time of the evidentiary hearing, neither Peak nor Kutrubes had filed a Chapter 11 plan (Trial Tr. 43:7-16, June 11, 2020).
Kutrubes's emails with his accountants reflect that the plans are in their infancy (Trial Tr. 44:8-45:18, June 11, 2020) (Atlas's Ex. 22, p. 35). The time records attached to counsel for the Debtors' fee application similarly indicate that he spent a mere two hours preparing and discussing the plans with Kutrubes prior to expiration of the exclusive period (Trial Tr. 45:19-47:19, June 11, 2020) (Atlas's Ex. 36, p. 14).
Atlas argues that the Debtors' failure to file Chapter 11 Plans evidences an intent to "park in bankruptcy" while they appeal the Judgment in favor of Atlas.
I. Forum shopping
After the Debtors objected to Atlas's motion for relief from stay regarding the Stock Ownership Suit, Kutrubes and Biowest filed a stipulated motion for Biowest to turn over the purported consideration for the stock transfer to Kutrubes (Atlas's Ex. 28). This is true even though it had not yet been determined whether such transfer was valid, or whether any consideration was actually due to Kutrubes. On the petition date, the same motion was pending in the Stock Ownership Suit, wherein Judge Arguello entered orders enjoining the parties from taking any action to transfer the serum to Kutrubes or Peak until the Stock Ownership Suit was resolved. At the stay relief hearing on February 12, 2020, this Court expressed its belief that the filing of the stipulated motion in Kutrubes's bankruptcy case appeared to constitute an attempt to make an end run around Judge Arguello's injunction (Trial Tr. 80:12-22, June 11, 2020). Thereafter, Kutrubes withdrew the stipulated motion.
J. Excessive salary
Kutrubes has no written salary agreement with Peak, and he is responsible for setting his own salary (Trial Tr. 106:25-107:7, June 10, 2020). Kutrubes, pursuant to the stipulated cash collateral agreement with First National Bank of Omaha, has established his salary at $12,000 per month (Trial Tr. 107:8-107:12, June 10, 2020). Between November 2019 and January 2020, Kutrubes also took distributions on top of his monthly salary in the total amount of $34,305 (Trial Tr. 107:13-107:20, June 10, 2020) (Atlas's Exs. 10-12).
Atlas argues that, as evidenced by Kutrubes's monthly operating reports, his salary is excessive. Specifically, in January 2020, after payment of his monthly expenses, Kutrubes was left with an end-of-month balance of nearly $18,000 (Trial Tr. 108:12-109:4, June 10, 2020) (Atlas's Ex. 12). In February 2020, Kutrubes had an adjusted end-of-month balance of approximately $14,000 (Trial Tr. 120:18-121:13, June 10, 2020) (Atlas's Ex. 13). In March 2020, Kutrubes had an end-of-month balance of nearly $33,000 (Trial Tr. 134:19-136:2, June 10, 2020) (Atlas's Ex. 14). In April 2020, Kutrubes had an end-of-month balance of more than $24,000 (Trial Tr. 137:5-137:18, June 10, 2020) (Atlas's Ex. 15).
K. Lavish standard of living
In February 2020, shortly after Kutrubes returned from Peak's Mexico trip, he took his family on a two-day ski trip to Beaver Creek. Kutrubes and his family stayed in a luxury hotel and paid for ski lessons, equipment rentals, lift tickets, and nice meals, all of which cost more than $2,500 (Trial Tr. 124:2-125:1; 126:19-128:3, June 10, 2020) (Atlas's Ex. 16). Kutrubes's monthly operating reports (Atlas's Exs. 10-15) reflect that, each month, excessive sums are spent on meals, entertainment, health club costs, and other purchases.
Kutrubes also contributed $4,240 dollars to his 401(k) account one week prior to the petition date (Trial Tr. 148:13-149:10, June 10, 2020) (Atlas's Ex. 26, p. 100).
L. False representations in pleadings and discovery responses
In Kutrubes's motion to authorize the transfer of funds which purportedly belonged to his non-filing spouse, Carla Kutrubes, to a segregated bank account (Atlas's Ex. 25), Kutrubes misrepresented to the Court that he had not withdrawn or deposited any funds into that account and that it was used solely by Carla Kutrubes to deposit her earnings from work. Bank statements for the account (Atlas's Ex. 27) reflect that, in 2019, Kutrubes made regular deposits into the account in the total amount of $6,032 (Trial Tr. 159:24-170:5, June 10, 2020). The bank statements (Atlas's Ex. 27) further reflect that an insurance check for hail damage, made payable both to Kutrubes and Carla Kutrubes in the amount of $14,598.10, was both deposited into and withdrawn from the account one month pre-petition (Trial Tr. 157:18-159:15, June 10, 2020).
Additionally, when Atlas requested Kutrubes's 2019 W2 in discovery, Kutrubes declared under penalty of perjury that he did not have it (Atlas's Ex. 44, Supp), even though he indicated otherwise in prior in emails to his accountants (Trial Tr. 30:20-33:8, June 11, 2020) (Atlas's Ex. 22, p. 27).
M. Transactions without Court authority
On his Schedule A/B, Kutrubes listed a 100% interest in a single-member LLC called TCCC Properties, LLC ("TCCC"). Kutrubes's 2018 tax return reflected that TCCC reported income of $23,500 in 2018 and $14,000 in 2017 (Atlas's Ex. 32). Despite Kutrubes's knowledge that TCCC was property of his bankruptcy estate, he unilaterally and without prior notice or Court authority, dissolved TCCC post-petition (Trial Tr. 14:19-15:17, June 10, 2020) (Atlas's Ex. 33).
Further, on May 27, 2020, the Court granted the Debtors' request to continue use of cash collateral pursuant to the stipulated agreement with First National Bank of Omaha, through and including June 10, 2020. The Debtors' cash collateral budget projected that Peak would order $50,000 in consumable inventory in June 2020 (Atlas's Ex. 37). However, Kutrubes testified that Peak likely spent far more than $50,000 on consumable inventory in the form of certain gloves that can be used as personal protective equipment ("PPE") against COVID-19, and that Peak made no budget variance request to either the bank or the Court to obtain approval for such spending (Trial Tr. 107:23-109:12, June 18, 2020).
Finally, Kutrubes changed accountants in January 2020 to Eide Bailly. An application to employ Eide Bailly was never filed with the Court, such that the Court, creditors, and parties in interest were unaware that it was assisting in the preparation of the Debtors' financial reports (Trial Tr. 29:21-30:12; 33:8-34:24, June 11, 2020) (Atlas's Ex. 22, p. 29).
N. Payment of antecedent debts
Kutrubes's December 2019 Monthly Operating Report reflects that Kutrubes made a number of payments from his debtor-in-possession account on account of antecedent debts, including, but not limited to, the following:
• Eide Bailly in the amount of $1,858.40;
• Wick and Trautman in the amount of $540 (refunded);
• Jim Kutrubes for $275 in the amount of a fishing trip (refunded);
• Two payments to Bank of Colorado in the amount of $431.34 each;
• Skye Peterson in the amount of $1,083 for "1st place, fantasy football winnings;"
• S.T. Luxor in the amount of $1,057 for fantasy football winnings;
• Kipp Klein in the amount of $154 for fantasy football winnings; and
• Robbie Bergr in the amount of $79 for fantasy football winnings;
(Trial Tr. 110:21-114:1; 122:4-8; 128:23-131:7, June 10, 2020) (Atlas's Ex. 11).
O. Failure to avoid fraudulent transfers or preferences
Peak has failed to avoid a possible preferential or fraudulent transfer to Kutrubes's spouse, Carla Kutrubes ("Carla"), for its payment to her on October 23, 2019, in the amount of $12,000 for alleged past work that she performed (Atlas's Ex. 1, p. 24). At the meeting of creditors pursuant to 11 U.S.C. § 341 on December 19, 2019, Kutrubes could not recall what work Carla had performed to earn the $12,000 payment (Trial Tr. 152:3-8, June 10, 2020) (Atlas's Ex. 58). Kutrubes testified that Carla has no written compensation agreement, no set hourly rate, no set payment or work schedule, and no set job duties (Trial Tr. 152:10-153:3, June 10, 2020). Kutrubes presented evidence that Carla was paid in December in prior years, but, in 2019, she was paid one month pre-petition in October.
Peak has also failed to avoid preferential transfers made to Kutrubes's parents. Peak's Statement of Financial Affairs ("SOFA") reflects that it paid Kutrubes's parents a total of $85,000 on account of a loan within the year prior to the petition date (Atlas's Ex. 1, p. 24). In fact, Peak paid Kutrubes's parents a total of $165,000 within the year prior to the petition date, including a payment in the amount of $10,000, made one week pre-petition on November 6, 2019 (Trial Tr. 45:6-47:22, June 10, 2020) (Atlas's Ex. 73, p.9).
Additionally, Kutrubes testified that he had not given any thought to Peak avoiding potential preferential transfers made to the fantasy football winners (Trial Tr. 119:14-22, June 24, 2020).
Atlas argues that there is a conflict of interest which prevents Kutrubes from avoiding these payments to insiders.
P. Inaccurate Schedules and Statement of Financial Affairs
In January 2019, Eide Bailly began analyzing Peak's tax liability for potential sales tax liabilities in the State of California (Atlas's Ex. 22, p. 11-16). On February 24, 2020, Eide Bailly concluded that taxes were due on over $539,000 in sales (Trial Tr. 26:22-27:14, June 11, 2020) (Atlas's Ex. 22, p. 16). The Debtors failed to disclose this to any party. To date, Peak has not amended its schedules or provided any notice to the State of California or any other creditor that there is a potential liability of taxes due on over $539,000 in sales that was not listed on Peak's Schedules, or that any post-petition liability that exists.
To date, Peak has also failed to amend its SOFA to reflect that, as set forth above, it paid Kutrubes's parents a total of $165,000 within the year prior to the petition date, not $85,000 (Atlas's Ex. 1, p. 24). Peak has similarly failed to amend this answer on its SOFA to disclose the dates of the various payments made to Kutrubes's parents within the year prior to the petition date, even though Kutrubes swore under oath at the meeting of creditors pursuant to 11 U.S.C. § 341 on December 19, 2019, that he would do so (Trial Tr. 47:23-48:1, June 10, 2020) (Atlas's Ex. 58).
Further, Peak has failed to disclose its executory consulting contract with Jim DeOlden, its quality assurance consultant, on Peak's Schedule G (Atlas's Ex. 1, p. 19) (Atlas's Ex. Q).
Finally, Peak has failed to list any of the fantasy football winners as creditors on its Schedule E/F (Atlas's Ex. 1, pp. 16-18).
III. Analysis
Because Atlas made separate requests for the appointment of a Chapter 11 trustee in Peak and Kutrubes's Cases and alleged facts in support thereof that may or may not pertain to the Cases with equal force, the Court will now analyze each of the Cases individually.
A. Peak's case
Atlas advanced a multitude of arguments as to why the Court should order the appointment of a Chapter 11 trustee in Peak's case. In the interest of brevity, the Court will focus its analysis on the five arguments which the Court finds are most compelling and unrefuted by the Debtors.
First, Kutrubes admitted, both before Judge Arguello and this Court, to taking a series of dishonest actions in the formation of Peak (Trial Tr. 99:5-100:1, June 10, 2020) (Atlas's Ex. 3, pp. 4–5). Specifically, unbeknownst to Atlas, Kutrubes "took certain information, documentation, and data" from Atlas by emailing documents from his Atlas-provided email account to his personal Gmail account. These documents included Atlas's customer contact lists; a supplier agreement; its quality manual; its organizational chart; a contract manufacturing statement; proofs of labels; a marketing brochure; and email exchanges about Atlas's products, among others. Kutrubes also "sent certain emails to customers of [Atlas]" that contained Atlas's trademarks and trade names and "solicited business for his company, Peak Serum." In these emails, Kutrubes falsely represented to Atlas's customers that Atlas and Peak were "sister companies," that Atlas was no longer conducting international business, and that Peak would be assuming Atlas's international customers. Kutrubes also contacted Atlas's suppliers, contract manufacturers, and business partners in attempt to secure product for Peak.
Second, Kutrubes conceded, before both Judge Arguello and this Court, that he breached the fiduciary duty of loyalty he owed to Atlas as an employee, in the formation of Peak (Trial Tr. 98:11-13, 100:2-5, June 10, 2020) (Atlas's Ex. 3, p. 10). Judge Arguello also concluded that Kutrubes breached the fiduciary duty he owed to Atlas as a director, in the formation of Peak (Atlas's Ex. 3, p. 10). "In a Chapter 11 case, the debtor in possession has a fiduciary duty to act not in its own best interest, but rather in the best interest of the entire estate, including secured and unsecured creditors." In re Whitney Place Partners , 147 B.R. 619, 620 (Bankr. N.D. Ga. 1992) (citing Commodity Futures Trading Comm'n v. Weintraub , 471 U.S. 343, 105 S.Ct. 1986, 85 L.Ed.2d 372 (1985) ). The Court is hard-pressed to justify how Peak can remain a debtor-in-possession, and how Kutrubes can continue to manage Peak, when Kutrubes has admittedly breached his fiduciary duties to Atlas, the Debtors' largest creditor.
Third, Judge Arguello concluded pre-petition that Peak had mislabeled fetal bovine serum lot 31C141. This Court concludes that Peak also mislabeled bovine serum lot 18K161. Although Atlas tested only one bottle of bovine serum from lot 18K161 (Atlas's Ex. 49), Cheever credibly testified that, as a result of the bovine serum manufacturing process, one bottle of serum is representative of its entire lot (Trial Tr. 40:12-21, June 16, 2020). The bottle of serum that was tested by Atlas possessed a tamper-resistant heat shrink seal and was unopened (Trial Tr. 49:19-25, June 16, 2020) (Atlas's Ex. 49). The Debtors argue that there is no evidence that lot 18K161 was properly stored from the time that it left Peak's hands in or around June 2017, until the time that it was tested by Atlas in February 2020. However, Cheever credibly testified that even if a lot of bovine serum were improperly stored (i.e., not kept frozen at the proper temperature), the marker levels used to determine whether serum is fetal bovine serum would degrade, not rise (Trial Tr. 50:5-22, June 16, 2020). In other words, if lot 18K161 were stored improperly, it would actually benefit the Debtors by lowering the IgG level of the serum to a level that is closer to the industry standard of < 500 micrograms per milliliter. Yet, at all times that lot 18K161 was tested, the IgG level was at least 840 micrograms per milliliter, and the GGT level was 176 international units per liter (Debtors' Ex. E).
Both Cheever (Trial Tr. 32:2-10, June 16, 2020) and the Debtors' expert witness, Suresh Daniel (Trial Tr. 130:22-131:17, June 16, 2020), testified that based upon the IgG and GGT levels set forth in the independent certificate of analysis performed by Omega (Debtors' Ex. E), lot 18K161 was not fetal bovine serum. Regardless of whether Omega incorrectly certified lot 18K161 as fetal bovine serum (see Trial Tr. 116:16-117:23, June 16, 2020; Trial Tr. 54:6-56:3, June 18, 2020), Peak altered Omega's independent certificate of analysis for lot 18K161 to reflect that the IgG level of lot 18K161 was 77 micrograms per milliliter—well within the industry standard of < 500 micrograms per milliliter to be considered fetal bovine serum—and not the actual level of 840 micrograms per milliliter, before tendering the certificate of analysis to Sumagen (Compare Atlas's Ex. 50, with Atlas's Exs. 51, p. 1; 64). This suggests to the Court that Peak's mislabeling of lot 18K161 was, more likely than not, dishonest.
While the mislabeling of lot 18K161 is evidence, at a minimum, of incompetence and gross mismanagement on the part of Peak, contrary to Atlas's allegations, there is no evidence that such mislabeling has continued post-petition. It is true that the suspected adulteration of lot 18K161 was not brought to Atlas's attention until February 2020. However, the evidence establishes that lot 18K161 was manufactured pre-petition in August 2016 (Atlas's Exs. 50; 64). When asked by the Court if Atlas had tested any lots of serum manufactured post-petition, Atlas represented that it had not (Trial Tr. 79:7-14, June 24, 2020). Thus, the most recent evidence before the Court of serum tested post-petition was offered by the Debtors and shows that lots 17F1182 and 31G1191, tested in March 2020, were, in fact, fetal bovine serum (Debtors' Exs. C-D).
The Court is unaware of the date that lots 17F1182 and 31G1191 were manufactured, and whether such dates were pre- or post-petition, as no evidence of the manufacture dates of these lots was submitted to the Court.
Additionally, the Court notes that Peak hired Jim DeOlden ("DeOlden"), a quality assurance expert, in late-2016 to put quality assurance procedures in place to ensure the integrity of Peak's serum (Trial Tr. 44:15-46:20, June 18, 2020) (Debtors' Ex. Q). DeOlden credibly testified regarding such procedures, which include a supplier questionnaire, supplier audits, supplier in-person inspections, and follow up (Trial Tr. 146:14-148:9, June 16, 2020). The Court also notes that Peak has voluntarily subjected itself to periodic USDA audits since 2017 and has received annual USDA approvals regarding Peak's compliance since that time (Trial Tr. 57:21-59:16, June 18, 2020) (Debtors' Ex. R, pp. 25-30). However, these facts do not negate Peak's prior mislabeling or ongoing failure to take any action to determine whether the mislabeled lots are still in use by customers and, if so, to recall the mislabeled lots. Peak's failures in this regard have exposed its estate to potential liabilities not accounted for on Peak's Schedules.
Fourth, with respect to Peak's financial reporting obligations, it is uncontroverted that Peak's Monthly Operating Reports for November 2019 through April 2020 (Atlas's Ex. 4-9) were inaccurate and required amendments. In fact, Kutrubes knew as far back as December 31, 2019, that Peak's November 2019 Monthly Operating Report was inaccurate and had to be amended (Trial Tr. 22:13-:20, June 11, 2020) (Atlas's Ex. 22, p. 8). Notwithstanding that Kutrubes signed the amended Monthly Operating Reports for November 2019 through April 2020 (Debtors' Ex. G) on May 29, 2020, they were not filed with the Court until June 5, 2020—five days before the commencement of the evidentiary hearing and the day that witness lists and exhibits for the same were due to be filed. The Court takes judicial notice that the Monthly Operating Reports for November 2019 through April 2020 were further amended on November 9, 2020 (Case No. 19-19802, Docs. 285-287; 289-290; 293; 297).
Under Fed. R. Evid. 201, a court may, sua sponte , take judicial notice of the filings on its own docket. St. Louis Baptist Temple, Inc. v. Fed. Deposit Ins. Corp. , 605 F.2d 1169, 1172 (10th Cir. 1979).
Similarly, Peak waited until the morning of June 24, 2020—the date that the evidentiary hearing was scheduled to conclude—to file its May 2020 Monthly Operating Report (Atlas's Ex. 71). This is true even though the May 2020 report was due to be filed on June 21, 2020, was signed by Kutrubes on June 21, 2020, and Kutrubes testified that the May 2020 report was ready to be filed on June 21, 2020 (Trial Tr. 28:17-29:25, June 24, 2020).
"Timely and accurate financial disclosure is the life blood of the Chapter 11 process." Matter of Berryhill , 127 B.R. 427, 433 (Bankr. N.D. Ind. 1991). Because monthly operating reports enable creditors to stay informed about a debtor's post-petition operations, "untimely and inadequate monthly operating [reports] may be so useless as to be the practical equivalent of a failure to file any operating [report] at all." In re Ronald Kern & Sons , No. 01-BK-12835K, 2002 WL 1628908, at *2 n.3 (W.D.N.Y. June 11, 2002). For this reason, the same can be said of untimely amended monthly operating reports.
Finally, despite the amendments made to Peak's Monthly Operating Reports for November 2019 through April 2020 (Debtors' Ex. G), showing an increase in Peak's cash flow, the amended reports and the May 2020 Monthly Operating Report (Atlas's Ex. 71) still reflected an overall accrual-based loss. While Mark Dennis, the Debtors' accountant, testified as to one possible reason why Peak may be cash flow positive and still show an accrual-based loss, he also testified that he had not analyzed Peak's accounts payable to determine whether Peak had sufficient cash to pay its obligations as they came due or whether any such obligations were actually overdue (Trial Tr. 70:17-72:5, June 16, 2020). Moreover, Peak's cash collateral budget and projections reflect that its losses will continue each month from July 2020 through December 2020 (Trial Tr. 53:25-54:5, June 11, 2020) (Atlas's Exs. 37; 39). Peak estimated that such losses during this period will total $1,403,688 (Atlas's Ex. 37).
The Debtors argue that, while Peak's cash collateral budget and projections accurately project its future expenses, they do not function to limit its future income. In fact, the Debtors assert that, in light of COVID-19, anticipated revenues from the sale of certain PPE gloves would render Peak indisputably profitable (Debtors' Exs. H; I). However, the Court finds that the anticipated revenues from the sale of the gloves are highly speculative for two reasons. First, at the conclusion of the evidentiary hearing, Peak's glove purchase orders had not yet been fulfilled (Trial Tr. 20:25-21:22, June 18, 2020). Indeed, due to delays related to COVID-19, the gloves had not even been made, let alone shipped to Peak by the supplier for sale to its customers (Trial Tr. 21:12-15, June 18, 2020). Second, Kutrubes testified that the gloves were a relatively new product to Peak, that the amount of anticipated revenues from the sale of the gloves was calculated based upon a recent increase in demand, and that, as a non-serum product, the gloves were not Peak's primary product line (Trial Tr. 14:3-24; 20:8-24, June 18, 2020).
Even assuming that, as predicted by the Debtors, Peak is now profitable, it would not outweigh the other facts set forth above. Indeed, Kutrubes conceded that, as a result of his dishonest actions and breach of fiduciary duties, there is "significant acrimony" between himself/Peak and Atlas, and that he does not know if Atlas believes it can trust him (Trial Tr. 103:19-23, June 10, 2020). Rick Paniccia ("Paniccia"), the owner and president of Atlas, similarly testified to the level of acrimony and mistrust between Atlas and Kutrubes/Peak (Trial Tr. 158:17-159:7, June 11, 2020). Specifically, Paniccia testified that he believes Kutrubes is not trustworthy, that he has no confidence in Kutrubes to reorganize Peak, and that Kutrubes has grossly mismanaged Peak, as evidenced by Peak's "mess[y]" financials (Trial Tr. 157:6-158:2, June 11, 2020).
Thus, regardless of whether the Court employs a preponderance of the evidence standard or a clear and convincing standard, Atlas has met its burden. The above facts, when viewed in the totality of the circumstances, warrant the appointment of a Chapter 11 trustee in Peak's case.
The Court finds that, under 11 U.S.C. § 1104(a)(1), cause exists to appoint a Chapter 11 trustee. 11 U.S.C. § 1104(a)(1) requires the Court to consider, inter alia , "fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case." It is uncontroverted that, pre-petition, Kutrubes undertook a series of dishonest actions in the formation of Peak. It is also unrefuted that Peak mislabeled several lots of bovine serum pre-petition. Post-petition, Peak has failed to take any action to determine whether the mislabeled lots are still in use by customers and, if so, to recall the mislabeled lots. Peak's failures with respect to the mislabeled serum amounts, at a minimum, to incompetence and gross mismanagement of Peak by Kutrubes. The same can be said of Peak's perpetually inaccurate and untimely amended monthly operating reports.
Moreover, the Court finds that appointment of a Chapter 11 trustee is in the best interests of the estate and its creditors under 11 U.S.C. § 1104(a)(2). The acrimony between Kutrubes/Peak and Atlas, the Debtors' largest creditor, is palpable. The mistrust between the parties, rooted in Kutrubes's dishonest actions and breach of fiduciary duties to Atlas in the formation of Peak, has been fueled post-petition by Peak's ongoing failure to provide timely and accurate financial reports. Atlas's inability to trust Kutrubes and lack of confidence in Kutrubes to reorganize or manage Peak has resulted in a deadlock between the parties. As a result, the benefit that parties would derive from Peak's management by a neutral third-party outweighs any costs associated with the appointment of a Chapter 11 trustee in Peak's case.
B. Kutrubes's case
The Court notes that the same acrimony and mistrust present in Peak's case is also present in Kutrubes's case. However, the Court finds that Atlas presented little additional, unrefuted evidence to compel the appointment of a Chapter 11 trustee in Kutrubes's case.
Kutrubes exemplifies the purest form of an individual Chapter 11 debtor. Kutrubes is not a sole proprietor. Nor does he manage any significant amount of real property. Indeed, Kutrubes does not generate any income outside of his relationship with Peak. Because there would be little for a Chapter 11 trustee to manage in Kutrubes's case, the costs associated with the appointment of such trustee would certainly outweigh any benefit derived by the estate. In fact, the Court believes that many of Atlas's concerns regarding Kutrubes's case (i.e., "excessive" salary, "lavish" lifestyle, etc.) are adequately addressed by the appointment of a Chapter 11 trustee in Peak's case.
For these reasons, the Court finds that, regardless of whether a preponderance of the evidence standard or a clear and convincing standard is employed, Atlas has failed to establish cause for the appointment of a Chapter 11 trustee in Kutrubes's case, or that such appointment is in the best interests of the estate and its creditors. Instead, the Court finds that the Debtors have established cause to dismiss Kutrubes's case.
A court may find that cause exists to grant a debtor's motion to voluntarily dismiss his Chapter 11 case when there has been a material change in circumstances postpetition. Here, changes in the law ushered in by both SBRA and the CARES Act constitute such a material change in circumstances.
Historically, standard Chapter 11 cases have been a poor fit for many individual Chapter 11 debtors. See e.g. , Richard M. Hynes et. al., National Study of Individual Chapter 11 Bankruptcies , 25 Am. Bankr. Inst. L. Rev. 61, 164 (2017) (finding that that a little more than one third of individuals in Chapter 11 "succeed" by confirming a plan and avoiding dismissal or conversion for 881 days). Indeed, the absolute priority rule has proven an insurmountable obstacle for many individual Chapter 11 debtors. See id. (finding that individual Chapter 11 debtors are more likely to succeed in jurisdictions following the broad, rather than the narrow, interpretation of the absolute priority rule). SBRA, as amended by the CARES Act to temporarily expand a debtor's eligibility to proceed under Subchapter V, has streamlined the Chapter 11 process for small business debtors and, particularly, for individual Chapter 11 debtors. For example, 11 U.S.C. § 1181 provides that 11 U.S.C. § 1129(b), which contains the absolute priority rule, does not apply in Subchapter V cases.
However, Atlas argues that if the Court were to permit Kutrubes to dismiss his case to refile under Subchapter V, creditors would be prejudiced. Atlas further argues that there is no guarantee that Kutrubes would even refile his bankruptcy case.
The Court notes that, while it cannot be certain that Kutrubes would refile his bankruptcy case, it may not be in Kutrubes's best interests to remain outside of bankruptcy, as there would be no impediment to Atlas's collection efforts on the Judgment. Moreover, if Kutrubes desires to benefit from the CARES Act's temporary increase of the debt limit to qualify as a debtor under SBRA, he must refile his case under Subchapter V prior to March 27, 2021, as set forth in the CARES Act's sunset clause. § 1113(a)(5), 134 Stat 281, 311.
While the streamlined provisions of Subchapter V may, in many ways, favor debtors, the Court notes that Subchapter V affords no shortage of protections for creditors such as Atlas. For example, because appointment of a trustee is automatic in Subchapter V cases, Kutrubes would be subject to some level of oversight by a neutral third party. Additionally, as an individual Chapter 11 debtor in Subchapter V, Kutrubes would be required to pay all of his disposable income to creditors under a Chapter 11 plan. See 11 U.S.C. § 1191. Finally, the Court notes that Atlas's ability to object to the dischargeability of the Judgment pursuant to 11 U.S.C. § 523 would be preserved in Subchapter V.
Accordingly, the Court finds that creditors, including Atlas, would not be prejudiced by the dismissal of Kutrubes's case to refile under Subchapter V. Rather, in light of the streamlined provisions of Subchapter V, intended to achieve a timely and cost-effective reorganization, see Paul W. Bonapfel, A Guide to the Small Business Reorganization Act of 2019 , 93 Am. Bankr. L.J. 571, 574 (2019), the Court finds that dismissal of Kutrubes's case is in the best interests of the estate and its creditors.
CONCLUSION
For the reasons set forth above,
IT IS ORDERED that the Debtors' Motion to Convert Cases to Sub-Chapter V Cases or in the Alternative to Allow Dismissal and Refiling of Cases (Case No. 19-19802, Doc. 161) is DENIED, in part, as to the Debtors' request to elect to proceed under Subchapter V.
IT IS FURTHER ORDERED that the Debtors' Motion to Convert Cases to Sub-Chapter V Cases or in the Alternative to Allow Dismissal and Refiling of Cases (Case No. 19-19802, Doc. 161) is DENIED, in part, as to Peak's request to dismiss its case.
IT IS FURTHER ORDERED that the Debtors' Motion to Convert Cases to Sub-Chapter V Cases or in the Alternative to Allow Dismissal and Refiling of Cases (Case No. 19-19802, Doc. 161) is GRANTED, in part, as to Kutrubes's request to dismiss his case. Case No. 19-19803 is hereby DISMISSED.
IT IS FURTHER ORDERED that Atlas's Motion for Appointment of Chapter 11 Trustee Pursuant to 11 U.S.C. § 1104(a)(2) in the case of Peak Serum, Inc. (Case No. 19-19802, Doc. 135) is GRANTED. The United States Trustee is hereby authorized to appoint a Chapter 11 Trustee in Case No. 19-19802.
IT IS FURTHER ORDERED that Atlas's Motion for Appointment of Chapter 11 Trustee Pursuant to 11 U.S.C. § 1104(a)(2) in the case of Thomas Kutrubes (Case No. 19-19803, Doc. 92) is DENIED.
IT IS FURTHER ORDERED that the November 18, 2019 Order Granting Motion for Joint Administration of the Cases under Case No. 19-19802-JGR (Doc. 38) is VACATED.