Opinion
Case No. 8:18-bk-05531-MGW
03-30-2020
IN RE: WALHOF PROPERTIES, LLC, Debtor.
Eric D. Jacobs, Esq., Genovese Joblove & Batista, P.A., Counsel for Stephen Meininger, Chapter 7 Trustee Benjamin G. Martin, Esq., Law Offices of Benjamin Martin, Counsel for Christiaan and Bettina Walhof
Eric D. Jacobs, Esq., Genovese Joblove & Batista, P.A., Counsel for Stephen Meininger, Chapter 7 Trustee
Benjamin G. Martin, Esq., Law Offices of Benjamin Martin, Counsel for Christiaan and Bettina Walhof
MEMORANDUM OPINION AND ORDER ON MOTION FOR TURNOVER
Michael G. Williamson, United States Bankruptcy Judge
Shortly before filing this case, Walhof Properties contracted to sell its primary asset—5.5 acres of land—for $3 million. After filing this chapter 11 case, Walhof Properties sought approval of the sale, although at a reduced price of $2.7 million, which the Court granted. The sales proceeds were enough to pay all creditors in full, leaving a surplus. Under the confirmed plan in this case, the surplus proceeds ultimately will be distributed to Christiaan and Bettina Walhof, who are currently in chapter 7 bankruptcy.
This Court must decide whether the surplus sales proceeds should be excluded from the Walhofs' individual chapter 7 estate as "earnings" for postpetition services under Bankruptcy Code § 541(a)(6). Because the significant services here—finding a buyer and negotiating a sale contract—occurred prepetition, the Court concludes that the surplus proceeds do not fall within the § 541(a)(6) earnings exception and therefore should be included in the Walhofs' individual chapter 7 estate.
I. BACKGROUND
Christiaan and Bettina Walhof indirectly own a 100% interest in Walhof Properties: Bettina Walhof owns a 1% interest in the company; the remaining 99% is owned by Walhof & Co. Mergers and Acquisitions, which, in turn, is owned by Christiaan and Bettina. Walhof Properties was in the real estate investment business.
Statement of Financial Affairs at 6 , Doc. No. 13; Schedule A/B Property at 6, In re Christiaan & Bettina Walhof , Case No. 8:18-bk-04295-MGW, Doc. No. 1-1.
Case Management Summary at ¶ 2, Doc. No. 14.
Its primary asset was 5.5 acres of land near the George Bush International Airport in Houston, Texas. For some time, Walhof Properties had been trying to sell the property. At one point, the broker that Walhof Properties had hired to sell the property offered to buy it. But Walhof Properties ended up in litigation with the broker, leaving Walhof Properties with substantial attorney’s fees. Eventually, Walhof Properties got to the point where it was unable to pay its mortgage, which led its lender to move forward with a non-judicial foreclosure sale.
Id. at ¶ 4.
Id.
Id.
Id.
Shortly before the foreclosure sale, Walhof Properties, with the help of a real estate broker, found a buyer willing to pay $3 million for the property. Although Walhof Properties had a signed sales contract in place, its lender refused to delay the foreclosure sale. To stop the foreclosure, Walhof Properties filed for chapter 11 bankruptcy.
Id. ; Commercial Contract – Unimproved Property at §§ 3 & 9, Doc. No. 32-1.
Case Management Summary at ¶ 4, Doc. No. 14.
Id .
Not long after this chapter 11 case was filed, the buyer decided it didn't want to buy a portion of the property. So the parties amended the sale contract. Under the amendment, the sales price was reduced to roughly $2.7 million. The Court approved the sale of the property for the agreed $2.7 million, which was enough to pay all creditors in full and leave a surplus. The Court must now determine who is entitled to the surplus sales proceeds. Ordinarily, this would be an easy question. Under the confirmed plan in this case, the surplus proceeds would be distributed to Walhof Properties' equity holders—Walhof & Co. and Bettina Walhof. But here’s the wrinkle: shortly before Walhof Properties filed for chapter 11 bankruptcy, Christiaan and Bettina filed their own chapter 11 case.
First Amendment to Commercial Contract – Unimproved Property at § 1, Doc. No. 32-1.
Order Granting Motion for Authority to Sell Real Property Which is Substantially Only Asset of Walhof Properties, LLC and Denying Motion to Assume Executory Contract , Doc. No. 63.
Debtor’s Amended Plan of Reorganization at 7, Doc. No. 67; Order Confirming Plan , Doc. No. 71.
Voluntary Petition , In re Christiaan & Bettina Walhof , Case No. 8:18-bk-04295-MGW, Doc. No. 1-1.
That case was eventually converted to chapter 7, and Stephen Meininger was appointed as the chapter 7 trustee. Because the Walhofs' 100% interest in Walhof & Co., along with Bettina’s 1% interest in Walhof Properties, is part of the Walhofs' chapter 7 estate, Meininger seeks turnover of any surplus sale proceeds. He believes the surplus proceeds are property of the Walhofs' individual estate. The Walhofs object to any surplus sales proceeds becoming property of their individual chapter 7 estate because they say the sales proceeds are "earnings," which are excluded from property of the estate under Bankruptcy Code § 541(a)(6).
Order Converting Case from Chapter 11 to Chapter 7 , Case No. 8:18-bk-04295-MGW, Doc. No. 113.
Interested Party, Stephen L. Meininger’s Motion for Turnover of Funds to the Chapter 7 Trustee , Doc. No. 90. The parties agree that Walhof & Co. has no creditors. So any distribution to Walhof & Co. will flow directly to the Walhofs.
Response to Interested Party, Stephen L. Meininger’s Motion for Turnover of Funds to the Chapter 7 Trustee , Doc. No. 92.
II. CONCLUSIONS OF LAW
Bankruptcy Code § 541 defines property of the estate. Under § 541, property of the estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case." Property of the estate also includes all proceeds generated from property of the estate. But § 541(a)(6) provides an exception: property of the estate does not include earnings from services performed by an individual debtor after the commencement of the case.
Id.
The sale proceeds in this case, of course, are not earnings for services performed by Walhof Properties. They are proceeds from the sale of estate property. Under the confirmed plan, the sales proceeds are akin to a distribution to Walhof Properties' members. In the Walhofs' individual case, the surplus sales proceeds are, in turn, distributions from Walhof Properties and Walhof & Co.
If anything, that would be "earnings" for services by the Walhofs. For that reason, Meininger’s turnover motion should have been filed in the Walhofs' individual case. But, since the turnover motion has been filed and fully briefed by both parties, the Court will determine what happens to the surplus sales proceeds when they flow to the Walhofs' individual chapter 7 estate.
Relying on In re Evans , the Walhofs contend that distributions from a closely held corporation can constitute "earnings" under § 541(a)(6). As a starting point, the Evans Court explained that "earnings" in § 541(a)(6) is not limited to "wages" or "salary." Congress used the terms "wages" and "salary" in other Code sections. Had it intended to limit "earnings" to "wages" or "salary" in § 541(a)(6), Congress could have easily done so. The Evans Court reasoned that by using the term "earnings," as opposed to "wages" or "salary," Congress intended to exclude from property of the estate "all income generated by an individual."
464 B.R. 429 (Bankr. D. Colo. 2011).
Id. at 435.
Id. (citing 11 U.S.C. §§ 503(b)(1)(A) and 507(a)(3)(A) ).
Id.
Id. at 435–36 (quoting Litzler v. Sholdra (In re Sholdra) , 270 B.R. 64, 69 (Bankr. N.D. Tex. 2001) ).
But, as the Evans Court went on to explain, the difficulty lies in determining how much of a distribution is attributable to an individual debtor’s personal services and how much is attributable to a closely held business' enterprise value. To come up with a framework for making that determination, the Evans Court looked to the Southern District of Texas Bankruptcy Court’s decision more than thirty years ago in In re Cooley .
Id. at 436.
Id. at 436–37 (citing In re Cooley , 87 B.R. 432, 441 (Bankr. S.D. Tex. 1988) ).
Under the Cooley framework, a debtor bears the burden of coming forward and showing that (1) she is an individual; (2) who performed postpetition services; (3) that generated earnings. Assuming the debtor makes the required showing, the burden then shifts to the opposing party to show that "earnings" are really proceeds or profits derived from property of the estate. Applying the Cooley framework, the Evans Court ruled that the distributions in that case were, in fact, earnings.
In re Cooley , 87 B.R. 432, 441 (Bankr. S.D. Tex. 1988).
Id. Section 541(a)(6) also excludes the product and offspring of or rent from property of the estate. But this case only involves proceeds or profits from property of the estate.
Evans , 464 B.R. at 438.
In Evans , the debtor served as the president of two bakeries, which had been operating 365 days a year for seventeen years, where he supervised 150 employees. The average salary of the presidents of fourteen similarly situated bakeries ranged from $400,000 – $600,000. But, rather than receive a straight salary, the debtor received a compensation package that consisted of salary and distributions. In fact, roughly only a quarter of the debtor’s compensation came from salary, while the remaining three quarters came from distributions.
Id.
Id.
Id. at 433.
The evidence established that the bakeries' board of directors wanted the debtor’s compensation to be mostly tied to distributions in order to motivate him to build the bakeries' business. The debtor’s total compensation (including the distributions) fell within the same range as the average salary for similarly situated bakery presidents. That evidence, the Evans Court concluded, satisfied the debtor’s initial burden of coming forward with evidence that the § 541(a)(6) earnings exception applied. The trustee, however, failed to meet his burden to show the distributions were something other than earnings. Among other things, the trustee did not dispute that the bakeries considered the distributions part of the debtor’s compensation. Nor did the trustee put on any evidence that the distributions the debtor received were attributable to the enterprise value of the business. Finding that the outcome rested on who ultimately carried the burden of persuasion, the Evans Court concluded that the trustee failed to establish that the distributions were proceeds, product, offspring, rent, or profits of or from property of the estate.
Id. at 438.
Id.
Id.
Id.
Id.
Evans is distinguishable from this case. Unlike in Evans , which involved two operating entities with more than 150 employees, Walhof Properties was not an operating entity. It was, in effect, a holding company whose primary asset was the 5.5 acres of land. More important, unlike in Evans , where the distributions were for two years of postpetition services, here most (if not all) the services the Walhofs would have performed were performed prepetition.
Schedule A/B , Doc. No. 13. In its schedules, Walhof Properties lists $3,035,200 in assets. Of that amount, the 5.5 acres of land accounts for $3,000,000. Id. The remainder is a $35,000 escrow account held by Walhof Properties' mortgage lender and $200 in the company’s checking account. Id.
In particular, the contract for the sale of the property that generated the surplus proceeds was negotiated and entered into prepetition. It’s worth noting that, based on the sale contract, it appears Walhof Properties located the buyer with the help of a real estate broker. Other than a minor amendment to the contract reducing the purchase price by roughly $300,000, which was negotiated postpetition, the sale contract this Court approved was the one entered into prepetition.
Commercial Contract – Unimproved Property , Doc. No. 32-1.
Id. at § 9.
The facts here are similar to those in In re Thomas , which was decided by the Eleventh Circuit seven years ago. In Thomas , the debtor was a real estate investor who flipped distressed properties for a profit. Prepetition, the debtor entered into an option contract that gave him the right to buy real property from Craig Mobley. At the time, the property was subject to a $220,000 mortgage in favor of Wells Fargo. With the help of third parties, the debtor negotiated a $130,000 discounted payoff with Wells Fargo. After filing for chapter 7 bankruptcy, the debtor exercised his option to buy the property from Mobley for $130,000 and then sold it for $179,000.
516 F. App'x 875 (11th Cir. 2013).
Id. at 876.
Id. at 876 – 77.
Id. at 877.
Id.
Id.
The chapter 7 trustee sought to recover the net sales proceeds. The bankruptcy court concluded that the proceeds were property of the estate. On appeal, the debtor argued that the sale proceeds were earnings from postpetition services and therefore excluded from the estate under § 541(a)(6). In rejecting that argument, the Eleventh Circuit began by emphasizing that § 541(a)(6) only applies to postpetition services personally performed by the debtor. The Eleventh Circuit went on to conclude that the debtor’s main role in the deal was to acquire the option contract, which he did prepetition. The task of negotiating a short sale and then listing the property for sale and selling it was done postpetition by third parties—not the debtor. "Because the post-petition portions of the ‘flipping’ scheme were performed by third parties—and not by [the debtor] himself—the sales proceeds [were] not exempted under section 541(a)(6)".
Id.
Id. at 878.
Id.
Id.
Id.
Here, putting aside the fact that it appears Walhof Properties used a real estate broker to find the buyer, all of the significant work—finding a buyer and negotiating a sale contract—occurred prepetition. To the extent any work was done postpetition, such as amending the contract, that work would have been de minimis in the context of the sale. De minimis acts, however, are insufficient.
Id.
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III. CONCLUSION
All the significant services—finding a buyer and negotiating a sale contract—were performed prepetition. Even if the Walhofs performed some services postpetition, the Court is convinced that the sales proceeds here are attributable to Walhof Properties' enterprise value—not any services performed by the Walhofs. Accordingly, it is
ORDERED :
1. The Trustee’s motion for turnover is GRANTED.
2. Any surplus proceedings from the sale of the 5.5 acres of property in
Houston, Texas shall ultimately flow to the Walhofs' individual chapter 7 estate. DATED: March 30, 2020.