Opinion
Case No. 3:20-bk-02569-RCT
05-04-2021
In re Wildwood Villages, LLC d/b/a Wildwood Country Resort, Debtor.
Chapter 11 ORDER DENYING MOTION TO ALLOW CLASS CLAIM
THIS CASE came before the Court for oral argument on the Motion to Allow Claim (Doc. 109) (the "Motion"), filed by the Creditors and Class Plaintiffs/Class Representatives, Vaughn R. Harris, Cheryl M. Harris, Art Spengler, Terrance Piotrowicz and Susan Piotrowicz (the "Class Plaintiffs"), the Debtor's response to the Motion (Doc. 146) (the "Response"), and the joinder to the Response (Doc. 305), filed by secured creditors Level Four Investments, LLC and North Tract, LLC. The issue presented is whether the Class Plaintiffs' proof of claim (the "Class Claim") should be permitted in this Subchapter V small business case. For the reasons set forth below, the Court will not authorize a class claim, but will establish simplified procedures designed to protect the interests of the members of the putative class.
FACTUAL BACKGROUND
Debtor filed a petition for relief under Subchapter V of Chapter 11 on August 28, 2020. The Debtor is a developer and has owned the recreational facilities and the common areas of Wildwood Country Resort ("Wildwood") since 2003.
Wildwood is a deed restricted, 55 and over, mobile home park community located in Sumter Country. There are 195 lots in Wildwood, of which the residents own approximately 150. Debtor owns the remaining lots.
As of the petition date, Debtor was already involved in litigation, dating back to 2012, with the Class Plaintiffs in Florida state court (the "State Court Case"). In the State Court Case, the Class Plaintiffs, who are current and former owners of lots in Wildwood, seek damages and injunctive relief against Debtor. Specifically, the State Court Case centers around the Class Plaintiffs' allegations that the Debtor had been overcharging the residents of Wildwood on assessments that the residents are required to pay pursuant to the Declarations of Restrictive Covenants to which each of the subdivisions in the community was subject.
The State Court Case, pending in Sumter County Circuit Court, is captioned under case number 2012-CA-001348.
In 2017, the state court entered an order that certified a class of less than one hundred and fifty current and former lot owners in Wildwood to pursue the claims asserted in the Class Plaintiffs' second amended complaint, other than the claims for fraud (the "Class Certification Order"). The state court, however, has not resolved any of the substantive claims asserted. Liability for damages and all claims for declaratory and injunctive relief remained pending as of the petition date.
The second amended complaint filed in the State Court Case includes the following counts: (I) Declaratory Action; (II) Equitable Accounting; (III) Fraud; (IV) Unjust Enrichment; (V) Quantum Meruit; (VI) Breach of Contract as to Hearty Host; (VII) Breach of Contract as to Water Wheel; (VIII) Breach of Contract as to Heritage Wood; (IX) Florida Deceptive and Unfair Trade Practices Act ("FDUTPA"); (X) Breach of Implied Fiduciary Duty; (XI) Constructive Fraud; and (XII) Imposition of Equitable Lien.
By the Motion, the Class Plaintiffs seek authority to allow a class claim under Rule 7023 of the Federal Rules of Bankruptcy Procedure ("Rule 7023"). The underlying basis for the Class Claim is the state court litigation against Debtor and others.
Rule 7023 expressly allows class certification in adversary actions by incorporating Rule 23 of the Federal Rules of Civil Procedure. Rule 9014 of the Federal Rules of Bankruptcy Procedure expand the applicability of Rule 23 to contested matters, at the court's discretion.
In its Response, Debtor argues that class action claims are disfavored in bankruptcy proceedings and that allowing the Class Claim would unduly burden and delay the reorganization of this Subchapter V case. Specifically, Debtor asserts that Class Plaintiffs are seeking class certification to assert claims that are not equally divisible, extend over too long a time, and involve too many estimated components to meet the requirements of Rule 23 of the Federal Rules of Civil Procedure ("Rule 23"). Debtor also argues that the Class Claim is weighted towards the approximately $1,500,000 in legal fees and that this case is an example of how the class device can become a "lawyer's vehicle," resulting in the primary beneficiary of the class certification being the lawyers. Ultimately, Debtor argues that Class Plaintiffs cannot satisfy the requirements of Rule 23(a) and Rule 23(b).
Kamen v. Kemper Fin. Servs., Inc., 908 F.2d 1338, 1349 (7th Cir. 1990), rev'd, 500 U.S. 90 (1991).
The putative Class Claim is in the amount of $6,024,957. The Class Claim includes: (a) $980,667 for Profit Margin Overcharges; (b) $132,844 for Unauthorized Bad Debt Expenses; (c) $234,743 for Unauthorized Depreciation Expenses; (d) $693,640 for Unauthorized Professional Fee Expenses; (e) $17,921.17 for Unauthorized Professional Fee Line of Credit Expenses; (f) $355,116 for Unauthorized Repairs & Maintenance Line of Credit Expenses; (g) $741,096 for Unauthorized Interest Expenses; (h) $410,669 for Unauthorized Payments to Unity Land Management; (i) $51,454 for Estimated Expense Overcharges in 2009, and 2010 only; (j) $914,078.67 for Prejudgment Interest; and (k) $1,492,728.11 in Class Plaintiffs' Attorneys' Fees and Costs. (Proof of Claim 5-3).
To expedite the protracted litigation in this case, the Court previously entered a comprehensive Case Management Order (the "CMO"). The CMO has been amended twice at the request of the parties. Relevant to this order, the CMO directs that any claim for an equitable lien or constructive trust be set forth in an adversary proceeding to be filed on or before June 14, 2021. Further, it is anticipated that such an adversary would name secured creditors having liens against Debtor's real property that are impacted by the equitable lien claims asserted. Debtor's secured creditors were not named in the State Court Case.
Doc. 211 (amended by Docs. 274 & 296).
DISCUSSION
A. Legal Standard
Most courts conclude that class proofs of claim are permissible in bankruptcy proceedings. The determination, however, of whether to allow and certify a class claim remains within the discretion of the bankruptcy court. Here, Class Plaintiffs ask the Court to invoke Rule 7023 in the contested matter related to Debtor's objection to the Class Claim.
In re Kaiser Grp. Int'l, Inc., 278 B.R. 58, 62 (Bankr. D. Del. 2002) ("The vast majority of courts conclude that class proofs of claim are permissible in a bankruptcy proceeding."); see, e.g., Reid v. White Motor Corp., 886 F.2d 1462, 1469 (6th Cir. 1989); In re Charter Co., 876 F.2d 866, 873 (11th Cir. 1989); In re Am. Reserve Corp., 840 F.2d 487, 493 (7th Cir.1988); In re Zenith Laboratories, Inc., 104 B.R. 659, 662 n.2 (D.N.J. 1989); In re Chateaugay Corp., 104 B.R. 626, 629 (S.D. N.Y. 1989); In re First Interregional Equity Corp., 227 B.R. 358, 366 (Bankr. D.N.J. 1998); In re Woodward & Lothrop Holdings, Inc., 205 B.R. 365, 370 (Bankr. S.D. N.Y. 1997); In re Sacred Heart Hosp. of Norristown, 177 B.R. 16, 22 (Bankr. E.D. Pa. 1995). But see Kahler v. FIRSTPLUS Fin., Inc. (In re FIRSTPLUS Fin., Inc.), 248 B.R. 60, 72 (Bankr. N.D. Tex. 2000) (concluding that class proofs of claim are improper in the bankruptcy context).
Although the Bankruptcy Code and Rules do not provide "express guidance" regarding the Court's exercise of its discretion in applying Rule 7023, "a pervasive theme is avoiding undue delay in the administration of the case. It follows that a court sitting in bankruptcy may decline to apply Rule 23 if doing so would . . . 'gum up the works' of distributing the estate." Several factors inform a court's decision whether to extend the application of Rule 23 to a proof of claim, including: "(1) whether the class was certified pre-petition; (2) whether the members of the putative class received notice of the bar date; and (3) whether class certification will adversely affect the administration of the estate." These factors are commonly referred to as the "Musicland factors," and "[n]o one factor is dispositive; a factor may take on more or less importance in any given case."
In re Ephedra Prods. Liab. Litig., 329 B.R. 1, 5 (S.D. N.Y. 2005) (quoting In re Woodward & Lothrop Holdings, Inc., 205 B.R. at 369); see also In re MF Glob. Inc., 512 B.R. 757, 763 (Bankr. S.D. N.Y. 2014).
In re Musicland Holding Corp., 362 B.R. 644, 654 (Bankr. S.D. N.Y. 2007).
In re Chaparral Energy, Inc., 571 B.R. 642, 646 (Bankr. D. Del. 2017).
Once a determination has been made to invoke Rule 7023, then the proposed claim must be examined considering the requirements for class certification in Rule 23. At that point, the analysis applying Rule 7023 is consistent with that under Rule 23.
B. Class Claims in Subchapter V Cases
The Small Business Reorganization Act ("SBRA") was enacted on August 23, 2019 and became effective on February 19, 2020. The provisions of SBRA are contained in Subchapter V of Chapter 11 of the Bankruptcy Code. The statute is designed and focused on reorganizing small businesses quickly and efficiently. The original definition of a small business included a cap for unliquidated debts of $2,725,625. That cap has been temporarily increased to $7,500,000 for two years in view of the global COVID-19 pandemic.
Small Business Reorganization Act of 2019, Pub. L. No. 116-54, 133 Stat. 1079 (2019).
See In re Seven Stars on the Hudson Corp., 618 B.R. 333, 336 (Bankr. S.D. Fla. 2020) (stating that Subchapter V of Chapter 11 "establishes an expedited process for small business debtors to reorganize quickly, inexpensively, and efficiently.").
Because a Subchapter V case is intended to provide for an expedited process, some of the requirements that are involved with a typical Chapter 11 case, which can add layers of expense and complexity, have been eliminated. Examples of these streamlined and cost-reducing reorganizational procedures include:
(1) strict timelines to move the case forward;
(2) the appointment of a Subchapter V trustee;
(3) no requirement to file a disclosure statement unless ordered by the court;
(4) the debtor has the exclusive right to file a plan;
(5) no consenting impaired class is needed so long as the plan does not discriminate unfairly and is fair and equitable to the dissenting class;Although these "extraordinary powers and cost-saving provisions granted to small business debtors are certainly laudable," it is important to keep in mind that "[t]he overall purpose and function of the Bankruptcy Code is to strike a balance between creditor protection and debtor relief." The procedural safeguards put in place to facilitate an expeditious process in a Subchapter V case help achieve an appropriate balance.
(6) the elimination of the absolute priority rule;
(7) committees of creditors and interest holders are appointed only if ordered by the court;
(8) the ability to pay administrative expenses over time under a plan; and
(9) no quarterly United States Trustee's fees.
In re Seven Stars, 618 B.R. at 340-41.
In re Travel 2000, Inc., 264 B.R. 444, 448 (Bankr. W.D. Mich. 2001).
Specifically, Subchapter V requires that the court conduct a status conference within sixty (60) days of the order for relief, that the debtor must file a status report fourteen (14) days before that status conference, and that a plan must be filed within ninety (90) days of the order for relief. 11 U.S.C. §§ 1188(a), (b), & (c). The Court, however, has the discretion to extend these deadlines.
As Subchapter V was only recently enacted and as class proofs of claim in a typical Chapter 11 case are not a routine occurrence, it is not surprising that no court has yet addressed the issue of whether a class proof of claim is allowable in a Subchapter V case. So, to this extent, Debtor is correct that this is an issue of first impression. Nevertheless, the Court rejects Debtor's initial argument that a class proof of claim is prohibited in a Subchapter V case.
Essentially, Debtor argues that a class proof of claim circumvents Congress' intent that there should not be creditor committees in a Subchapter V case. While true that creditor committees are disfavored in Subchapter V cases, the statute permits a bankruptcy court to use its discretion and appoint a creditors' committee in an appropriate case. Similar to the allowance of a class claim, the appointment of a committee in a Subchapter V case is within the discretion of the court. The Court can envision possible scenarios where a creditors' committee or a class claim may be an efficient and appropriate vehicle in a Subchapter V case, particularly while the debt limits are set at a higher level.
11 U.S.C. § 1102(a)(3) states: "Unless the court for cause orders otherwise, a committee of creditors may not be appointed in a small business case or a case under subchapter V of this chapter." Cause is not defined in the statute.
Accordingly, the Court does not rule out the possibility of a class claim in a Subchapter V case. Instead, the Court will apply the traditional analysis in exercising its discretion to determine (i) whether invocation of Rule 7023 is appropriate to permit the Class Claim and, if so, (ii) whether the Class Claim filed by Class Plaintiffs satisfies the requirements of Rule 23.
C. Whether to Invoke Rule 7023
Importantly, the Court must first determine that it is appropriate to apply Rule 7023 prior to analyzing whether the requirements of Federal Rule 23 have been satisfied. As explained by the court in Chaparral Energy:
In re Verity Health Sys. of California, Inc., No. 2:18-BK-20151-ER, 2019 WL 2461688, at *7 (Bankr. C.D. Cal. June 11, 2019).
Whether to permit a class action proof of claim is a matter of discretion. In exercising that discretion, a two-step analysis is performed. First, the court must decide whether it is beneficial to apply Bankruptcy Rule 7023, via Bankruptcy Rule 9014(c), to the claims administration process. Second, the court must determine whether the requirements of Federal Rule 23 have been
satisfied, such that a class proof of claim may properly be filed.
In re Chaparral Energy, Inc., 571 B.R. at 646 (internal citations omitted); see also Gentry v. Siegel, 668 F.3d 83, 93 (4th Cir. 2012) ("Civil Rule 23 factors do not become an issue until the bankruptcy court determines that Rule 7023 applies by granting a Rule 9014 motion. The issue on such a motion centers more directly on whether the benefits of applying Rule 7023 (and Civil Rule 23) are superior to the benefits of the standard bankruptcy claims procedures.").
As previously noted, courts generally look to the Musicland factors in deciding whether to invoke Bankruptcy Rule 7023 to permit a class claim. A thoughtful examination of the Musicland factors is needed because certifying a class may be "less desirable in bankruptcy than in ordinary civil litigation."
In re Ephedra Prod. Liab. Litig., 329 B.R. 1, 5 (S.D. N.Y. 2005).
"A class action 'permits the aggregation and litigation of many small claims that otherwise would lie dormant' and incentivizes the holders to participate in the proceeding when its claim otherwise is too small economically to pursue individually." In the right case, a class action can be an effective litigation tool because it allows for the litigation to occur in one court, versus several different courts, which is a more efficient means of resolving numerous amounts of claims.
In re USA Gymnastics, No. 18-09108-RLM-11, 2020 WL 1932340, at *4 (Bankr. S.D. Ind. Apr. 20, 2020) (citing In re Am. Reserve Corp., 840 F.2d 489 (7th Cir. 1988)).
In re USA Gymnastics, 2020 WL 1932340, at *4.
Bankruptcy courts are unique in that they are equipped to efficiently handle thousands of claims in one forum. Notably, "the principal function of bankruptcy law is to determine and implement in a single collective proceeding the entitlements of all concerned." "The superiority of a class action vanishes when a bankruptcy exists as the bankruptcy 'significantly changes the balance of factors to be considered' in determining whether Rule 7023 should apply to a class claim."
In re Am. Reserve Corp., 840 F.2d 489 (7th Cir. 1988).
In re USA Gymnastics, 2020 WL 1932340, at *4 (citing In re Ephedra Prod. Liab. Litig., 329 B.R. at 5).
Therefore, as recognized by the court in USA Gymnastics, the utilization of Rule 7023 "should be used sparingly in the bankruptcy context."
In re USA Gymnastics, 2020 WL 1932340, at *4.
1. Prepetition Certification
The fact that there was a class certification prepetition certainly weighs in favor of the Class Plaintiffs. However, that certification here, though well-founded in the state court litigation, makes little sense in this Subchapter V case.
"Even class actions that were certified prior to the filing for bankruptcy may ... be disallowed." In re Ephedra Prod. Liab. Litig., 329 B.R. at 5.
First, one hundred and fifty potential claimants in bankruptcy is of very little, if any, significance in a bankruptcy proceeding. The Bankruptcy Code and Rules are designed to effectively deal with thousands of claims in a single case. This allows bankruptcy courts to efficiently handle the filing and administration of all claims against a debtor. Other courts (state and federal) dealing with numerous small claims do not have these same resources and procedures. Class certification therefore provides to those courts some of the benefits and tools that bankruptcy courts are already well-equipped to handle.
The procedures built into the bankruptcy process have fundamental advantages that include: "(1) claimants can file claims at little or no cost, without need of counsel; (2) properly filed claims are deemed allowed under § 502(a) if not objected to, thus avoiding discovery costs; (3) it provides established mechanisms for notice and the management of large claims; (4) proceedings are centralized in a single court with nationwide service of process; and (5) all of the debtor's assets are under the control of the bankruptcy court, thus providing protection against a race to judgment by creditors." In re USA Gymnastics, 2020 WL 1932340, at *4; see also Gentry, 668 F.2d at 92-93; In re Bally Total Fitness of Greater New York, 411 B.R. 142, 145-46 (S.D. N.Y. 2009).
Second, the class certification in the State Court Case was for the purpose of pursuing damages as well as declaratory and injunctive relief. A proof of claim is for damages only. Indeed, there is already pending in this Court a separate adversary proceeding filed by an Ad Hoc Committee of Wildwood Lot Owners that is pursuing the same declaratory and injunctive relief, but with different counsel. Obviously, the very existence of the Ad Hoc Committee complicates the decision of whether to designate the Class Plaintiffs to file a class proof of claim on behalf of the Wildwood Lot Owners, but it also counsels that the rights of the Wildwood Lot Owners are well served already.
Ad Hoc Owners Committee v. Wildwood Villages, LLC, Adv. No. 3:21-ap-00007-RCT.
Third, the State Court's certification of the Class Plaintiffs did not include claims for fraud that might be asserted by the Wildwood Lot Owners. It is unclear whether the Class Plaintiffs are simply ignoring those claims in the proof of claim that has been filed. But if Wildwood Lot Owners have individualized claims for fraud, the bankruptcy claims process allows for such claims to be asserted efficiently.
Fourth, the Class Plaintiffs have filed their claim as a secured claim based on asserted equitable liens and constructive trust arguments. Whatever the ultimate viability of such claims, it is clear that—at this time—the Class Plaintiffs do not have an equitable lien or a constructive trust for anything impacting Debtor's real property. Those interests must be judicially established before they have any validity or can relate back to any point in history. Such claims also cannot be established in the context of a class proof of claim or any proof of claim for that matter. The Federal Rules of Bankruptcy Procedure require that claims of interests in property and/or the nature and extent of any claimed lien be addressed in an adversary proceeding.
"Under Florida law, an equitable lien may be imposed on one of two bases: (1) a written contract that indicates an intention to charge a particular property with a debt or obligation; or (2) a declaration by a court out of general consideration of a right or justice, as applied to the particular circumstances of the case." Performance Leasing Corp. v. Williams (In re Performance Leasing Corp.), 385 B.R. 317, 325 (Bankr. M.D. Fla. 2008).
"Under Florida law, a constructive trust 'arises through operation of law. Where one through fraud, abuse of confidence, or other questionable means gains property which in equity or good conscience he should not be permitted to retain, equity will raise a constructive trust.'" In re Royal W. Props., Inc., 441 B.R. 158, 170 (Bankr. S.D. Fla. 2010) (citing to Hallam v. Gladman,132 So.2d 198, 204 (Fla. Dist. Ct. App. 1961) (citation omitted).
"Due to their remedial nature, neither a constructive trust nor an equitable lien exists until a judicial determination establishes it. Once established, however, both remedies relate back in time to the conduct on which they are founded." In re Cedar Funding, Inc., 398 B.R. 346, 350 (Bankr. N.D. Cal. 2008).
Fed. R. Bankr. P. 7001(2) & (9).
The Court is further puzzled how Class Plaintiffs can obtain an equitable lien or constructive trust against real property on which there exist recorded mortgages without the mortgage holders being named in the litigation. Essentially, the loosely articulated potential claims against the mortgage holders would seem to require some type of subordination of the mortgages at issue. But since the potential action has not yet been filed, the Court is only guessing at this point. Notably, in a collective bankruptcy proceeding, the secured creditors are parties in interest whose rights may be impacted or subordinated by such a judicial determination. It is for this reason that the CMO established a deadline for filing an adversary proceeding by anyone asserting an equitable lien or constructive trust against any property of the Debtor. By setting the filing deadline, the CMO serves to protect the rights of the lot owners to assert their equitable lien claims against Debtor's property in an appropriate proceeding and with all necessary parties involved.
2. Notice of Bar Date
As to whether the members of the putative class received notice of the bar date, the Debtor states that it believes all putative class members have received actual or constructive notice of the bar date. The Class Plaintiffs, however, assert that "several" of the class members have not received notice of the bankruptcy case and are not listed on the matrix.
Regardless, at present, none of the lot owners have filed individual claims. The Court, however, has protected their right to do so by previously providing:
In the event that the Court disallows the claim as a class claim and otherwise rules under Federal Rule of Bankruptcy Procedure 7023 that the claims raised in the Class Action shall not otherwise be processed on a class-basis, then the individual Class Action members shall have forty-five (45) days from the date of that order to file individual proofs of claim.
Order Granting Creditors and Class Plaintiffs/Class Representatives' Motion to Extend Proof of Claim Deadline (Doc. 90).
Accordingly, this factor is of no real significance in this case.
3. Interference with Administration of the Bankruptcy Case
At oral argument, it was clear that counsel for the Class Plaintiffs had not thought through the mechanics of how the Class Claim would work in this Subchapter V case. At a minimum, notice of the class certification order and an opportunity to opt in or out would be required. Further, at some point, the lot owners and former lot owners would have to become involved and make some type of claim to get any distribution from the bankruptcy estate. So, from an efficiency perspective, it is logical to accomplish this now rather than later and notices should go out once rather than twice. Utilizing a standard claims process also will avoid the need to deal with those putative class members who decide to opt out of the class and file their own claim or who choose to assert a claim for fraud.
Finally, this case has a significant advantage over state court litigation and even a standard Chapter 11 bankruptcy case. This Debtor has a Subchapter V Trustee who is knowledgeable and proficient in administering claims. In the absence of a consensual plan, the Subchapter V Trustee is designated to oversee payments under any plan of reorganization. It will not be necessary to overlay a whole other distribution process.
Time is of the essence in a Subchapter V reorganization. Deadlines are short and no one wins when administrative costs eat up the limited resources of a small business debtor. In this Subchapter V case, way too much time and money have already been spent to now interpose an additional layer of procedures and fees that a class claim represents.
Therefore, under the circumstances of this case, the Court will exercise its discretion and decline to apply Rule 7023 to the Class Plaintiffs' claim. Having determined not to invoke Rule 7023 in this case, it is unnecessary to evaluate whether the Class Claim should be certified under Rule 23.
D. Simplified Claims Procedure
Instead of allowing a class claim, and consistent with this Court's prior ruling effectively extending the bar date for the Wildwood Lot Owners, the following simplified procedures will be implemented. Within seven (7) days of this Order, Debtor shall send a standard proof of claim form to every creditor on the amended Exhibit 3 to the Motion. The proof of claim form shall include a notice that all claims must be filed on or before June 25, 2021. In addition, any lawyer who asserts a prepetition claim against Debtor in connection with the State Court Case will be given the same opportunity to file a claim. All creditors will have the option of being treated as an unsecured creditor or a secured creditor.
Doc. 299 Ex. 3.
If any creditor elects to file a secured claim based on an asserted equitable lien or constructive trust theory, any payment on or consideration of the claim would necessarily be abated until an appropriate adversary is finally resolved. As previously stated, the CMO directs that any claim for an equitable lien or constructive trust must be advanced by an adversary proceeding filed not later than June 14, 2021.
For these reasons, it is ORDERED:
1. The Motion (Doc. 109) is DENIED.
2. Every creditor on the amended Exhibit 3 to the Motion, as well as any lawyer who asserts a prepetition claim again the Debtor in connection with the State Court Case, must file a claim with the Court on or before June 25, 2021.
3. This ruling is without prejudice to seek Rule 7023 certification in any future adversary seeking equitable relief.
ORDERED.
Dated: May 04, 2021
/s/_________
Roberta A. Colton
United States Bankruptcy Judge Attorney Jeffrey P Lieser is directed to serve a copy of this order on interested parties who do not receive service by CM/ECF and file a proof of service within three days of its entry.