On November 13, 2015, Judge Laurie Selber Silverstein of the Delaware Bankruptcy Court ruled on an emergency motion to appoint a trustee. Unfortunately for the movants, it is hard to argue it is an emergency when the debtor is almost out of cash, but has been running on fumes for the last several years with a massive equity cushion. The “Opinion” is available here.
On August 6, 2015, several creditors of Diamondhead filed an involuntary chapter 7 bankruptcy petition. Diamondhead moved to dismiss or convert to a chapter 11. Diamondhead asserts that the involuntary petition was filed in bad faith and that there is a bona fide dispute as to the debt held by the petitioning creditors. After analyzing and discarding the arguments that the case should be dismissed, Judge Silverstein examined the merits of appointing a trustee.
Judge Silverstein starts her analysis of applicable law by stating “An involuntary petition is an extreme remedy with serious consequences to the alleged debtor.” Opinion at *8. She continues, “An even more extreme remedy-the appointment of an interim trustee-is permitted by section 303(g) of the United States Bankruptcy Code, if necessary to preserve the property of the estate or to prevent loss to the estate.” Opinion at *8-9 (citations omitted). As can be expected in situations of extreme remedies, there is limited case law applying section 303(g). Opinion at *9.
Ultimately, Judge Silverstein rules in a manner befitting her foreshadowing, denying the “extraordinary relief” of appointing of an interim trustee. Opinion at *12. The petitioning creditors argue that 15 years of mismanagement has led to this bankruptcy, however, they did not provide any testimony that during a gap between the petition and eventual confirmation or trustee appointment anything would change. The debtor testified to the contrary, alleging that the property would not be sold and that there was no expectation of a diminution of property value. As of early fall 2015, the property (which was the sole asset of value held by the debtor) was appraised at $39 million, and liens totaled only $5 million. Opinion at *14. The debtor’s cash on hand was $70,000, but even expecting that to drop to $0 would not materially affect the value of the estate. Ultimately, the petitioners failed to clear the extraordinarily high bar required to appoint an interim trustee. Opinion at *13-14.
While a creditor may allege mismanagement, and while there may have been some level of bad action by a debtor, a petitioner must still satisfy the specific requirements of the relief they seek. The appointment of an interim trustee requires, at its essence, that the Court determine that if management of a debtor is not pulled out immediately, the entire estate will be destroyed. That is a particularly tough sell when the assets of a debtor are 7 times larger than its liabilities, even if it is suffering a liquidity crunch such that it cannot pay its debts as they come due.