The Highlands Group of Brunswick, LLC

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NORTH CAROLINA
WILMINGTON DIVISION
IN RE:
THE HIGHLANDS GROUP OF
BRUNSWICK, LLC
DEBTOR
CASE NO.
11-07628-8-SWH
ORDER DENYING MOTION TO DISMISS OR CONVERT,
DETERMINING CLASSIFICATION OF CLAIMS, AND
RESOLVING VALUATION MOTIONS
Primarily at issue are two motions filed by creditor Park Sterling Bank (“Park Sterling”): the
motion to dismiss or convert case, and the motion to determine classification of claims, both of
which were brought before the court for hearing on August 23, 2012, in Raleigh, North Carolina.
The court already has denied the motion to dismiss or convert by order entered on September 6,
2012, and this order sets forth the basis on which the court determined that there was no cause,
pursuant to § 1112(b)(1), to dismiss or convert this case. Additionally, as set forth below, the court
has determined that the separate classification of the deficiency claim of Park Sterling is appropriate.
Also before the court are Park Sterling’s motion to stay entry of an order regarding valuation
of collateral and its withdrawal of its motion for valuation, as well as the debtor’s responsive filings,
namely the debtor’s motion for valuation and objection to Park Sterling’s withdrawal of its motion
SO ORDERED.
SIGNED this 01 day of November, 2012.
________________________________________
Stephani W. Humrickhouse
United States Bankruptcy Judge
____________________________________________________________
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 1 of
12

for valuation. 	In light of the court’s ruling on dismissal, the court will allow the debtor’s motion
for valuation (the relevant testimony already having been taken), deny Park Sterling’s motion to stay
entry of any order regarding valuation, and deny as moot the debtor’s objection to Park Sterling’s
withdrawal of its motion.
BACKGROUND
The debtor, The Highlands Group of Brunswick, LLC (“Highlands”), owns a parcel of real
property known as the Highlands Forest Townhomes in Brunswick County, North Carolina.1 The
parcel consists of nine completed residential townhomes, 58 townhome pads, common areas and a
pool with pool house. 	On or about July 31, 2007, the debtor executed a promissory note (the
“Note”) in favor of Park Sterling in the amount of $4,344,000, which is secured by a lien on all of
the debtor’s property. 	As further security for the Note, a number of individuals executed
Commercial 	Guaranty 	Agreements 	(“Guaranties”), 	pursuant 	to 	which 	each 	guarantor
unconditionally guaranteed repayment of the debtor’s obligations to Park Sterling. 	The debtor
subsequently defaulted under the Note, and Park Sterling instituted foreclosure proceedings in
Brunswick County. On August 3, 2011, Park Sterling filed a civil action on the Note and Guaranties
against the debtor and the individual guarantors in Mecklenburg County Superior Court.
The debtor filed a petition under chapter 11 of the Bankruptcy Code on October 5, 2011.
The debtor filed a plan on December 30, 2011, in which it proposed to surrender to Park Sterling
all of its property, with the exception of one of the completed townhomes, in full satisfaction of Park
1 The facts set forth herein are taken largely from Park Sterling’s motion to dismiss or
convert. The debtor did not address the factual background of the case in its response to the motion,
and the court borrows from Park Sterling’s recitation solely for establishing the general factual
background for this order.
2
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 2 of
12

Sterling’s claim. 	The debtor sought to retain the townhome (Lot #2) to be liquidated, with the
proceeds distributed in payment of the allowed non-insider general unsecured claims, which totaled
$80,370.08 on the debtor’s schedules.
On February 1, 2012, Park Sterling filed a Motion for Valuation of Collateral in the
bankruptcy case. It also filed a motion for summary judgment against the guarantors (but not the
debtor) in the Mecklenburg County civil action. The motion for summary judgment was heard on
May 1, 2012, and on May 16, the state court entered a judgment in favor of Park Sterling and against
each of the guarantors (Harry W. Stovall, III (“Stovall”); Alexander O. McCarley; Harry W.
Stovall, IV; and Lori C. Stovall) in the amount of $2,511,698.61 (the debt plus 15% attorneys’ fees).
The guarantors filed a notice of appeal.
The valuation hearing in this court was conducted close on the heels of those events, and
took place on May 21-22, 2012, concluding on July 2, 2012.
After the first two days of the valuation hearing, the debtor filed, on June 4, 2012, an
amended plan in which the debtor proposed full surrender of its property to Park Sterling in
satisfaction of the secured claim. The debtor’s amended plan provided that its members (Stovall,
McCarley & Company, and Harry W. Stovall, IV) would pay the unsecured claims. 	Stovall, a
guarantor subject to the Mecklenburg County judgment, filed an individual chapter 11 case in this
court on June 22, 2012.
On July 20, 2012, Park Sterling withdrew its motion for valuation of collateral and asked the
court to stay entry of any order regarding valuation, citing a change in its strategy based upon the
debtor’s modification of the plan and Stovall’s bankruptcy filing. On July 24, 2012, Park Sterling
3
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 3 of
12

filed objections to confirmation of the plan and to the disclosure statement, as well as a motion to
dismiss or convert. The debtor filed responses and the court, in an order dated September 6, 2012,
denied the motion to dismiss or convert for the reasons that follow.
DISCUSSION
I. 	Motion to Dismiss or Convert
Park Sterling’s motion to dismiss or convert is in large part intertwined with its withdrawal
of the motion for valuation. In Park Sterling’s view, the facts of this case in its current posture
illustrate that the “true motive of the liquidating debtor” was
not to utilize Chapter 11 to restructure its business, but to achieve a favorable
valuation of the mortgaged property for the purpose of attempting to limit (or
eliminate) guarantor exposure. Such cases are filed for an improper purpose and in
bad faith and should be dismissed or converted to Chapter 7.
Park Sterling’s Mot. to Dismiss at p. 7 ¶ 39. Park Sterling’s assessment of the debtor’s motives are
shaped in large part by the fact of Stovall’s bankruptcy filing, which Park Sterling believes will
include an “attempt to modify the Judgment to obtain credit for the value of the Property, as
assigned by this Court.” Park Sterling’s Withdrawal of Mot. for Valuation at p. 2 ¶ 5. It is Park
Sterling’s position that the two bankruptcy cases are related in that the purpose of Stovall’s
bankruptcy case is “to attempt to capitalize on a favorable Court-determined valuation of the
Property for purposes of cram-down in the Debtor’s case by seeking a credit against the Judgment
in the Court-determined amount.” Park Sterling’s Mot. to Dismiss at p. 4 ¶ 27. The debtor, in
response, argued that its case was neither filed in subjective bad faith nor objectively futile, both of
which must be established for a case to fail the two-pronged test set out in Carolin Corp. v. Miller,
886 F.2d 693 (4th Cir. 1989). In its order denying the motion to dismiss, the court agreed with the
4
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 4 of
12

debtor and ruled that there was no cause, pursuant to § 1112(b)(1), to either dismiss or convert the
case.
Both parties agreed that the applicable test by which to determine whether the case was filed
in bad faith is derived from Carolin, in which the Court of Appeals for the Fourth Circuit
emphasized that whether to dismiss a case for bad faith is assessed pursuant to an intentionally
“stringent” test, the overall aim of which is to “determine whether the purposes of the Code would
be furthered by permitting the Chapter 11 petitioner to proceed past filing.” Id. at 701. That two-
part test derives from this explanation by the Carolin court:
For three distinct reasons, a generalized “good faith filing” requirement appears
implicit in § 1112(b). 	First, the provision lists objective circumstances which
presumably justify dismissal because of the futility of reorganization proceedings.
Second, and more significantly, the listed circumstances are generally consistent with
and may in fact affirmatively evidence a subjective lack of good faith on the part of
a Chapter 11 petitioner.
Id. at 699 (also noting, as the third indicator of a good faith requirement, that the statute permits
dismissal “for cause,” which the court saw as “further suggesting the propriety of dismissal in the
face of a petitioner’s lack of good faith”). The Carolin court acknowledged that “although separate
inquiries into each are required, proof inevitably will overlap.” Id. at 701. In this case, Park Sterling
rests its argument primarily on what it characterizes as the debtor’s subjective lack of good faith,
and the court turns to that inquiry first.
A. 	Subjective Bad Faith
The subjective bad faith inquiry is designed to “insure that the petitioner actually intends ‘to
use the provisions of Chapter 11 . . . to reorganize or rehabilitate an existing enterprise, or to
preserve going concern values of a viable or existing business.’” Id. (quoting In re Victory Constr.
Co., 9 B.R. 549, 564 (Bankr. C.D. Cal. 1981)). However, a debtor with no ongoing business may
5
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 5 of
12

file a chapter 11 petition, and it is clear that a bankruptcy court “may consider any viable and
effective method of reorganization, including full or partial liquidation.” In re Schofield-Johnson,
LLC, 2010 WL 174152 at *3 (Bankr. M.D.N.C. 2010) (“Section 1129(a) expressly permits a
Chapter 11 plan to be a plan of liquidation.”). In this liquidation context, it may be more helpful to
consider how the Carolin court rephrased the goal of the current inquiry: “Put obversely,” that court
said, “the aim of the subjective bad faith inquiry is “to determine whether the petitioner’s real
motivation is ‘to abuse the reorganization process’ and ‘to cause hardship or to delay creditors by
resort to the Chapter 11 device merely for the purpose of invoking the automatic stay, without an
intent or ability to reorganize his financial activities.’” Carolin, 886 F.2d at 701 (quoting In re
Thirtieth Place, Inc., 30 B.R. 503, 505 (9th Cir. Bankr. App. 1983)).
In Park Sterling’s view, this case represents an effort to benefit the guarantors and only the
guarantors, to the exclusion of all others. It cited parallels between the debtor’s case and other cases
that it found persuasive, the gist of which is that
[e]ach of those cases have similar threads: (a) a liquidating plan
which proposes to surrender the debtor’s sole asset to the mortgagor;
(b) the existence of a guarantor who is liable to the mortgagor and is
capable of paying; (c) pending litigation against that guarantor to
enforce the guaranty obligation; and (d) minimal unsecured creditors
who will either be paid by the guarantor or are in no better position
in bankruptcy than outside of it.
Park Sterling’s Mot. to Dismiss at p. 7 ¶ 38 (discussing In re Humble Place Joint Venture, 936 F.2d
814, 818 (5th Cir. 1991); In re North Vermont Assocs., L.P., 165 B.R. 340, 341-43 (Bankr. D.D.
Col. 1994)).
The court disagrees. The filing of a chapter 11 petition with the ultimate goal of surrendering
real property in a SARE context is not, by virtue of that goal, an illegitimate use of the bankruptcy
6
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 6 of
12

process; further, the fact that guarantors may benefit from this process does not, of itself, establish
bad faith. 	Section 1129(a) requires that a plan and its proponent comply with the applicable
provisions of chapter 11, and that a plan be in good faith and not proposed by any means forbidden
by law. In this case, it is plain that equity holders who, here, are also guarantors, have legitimate
interests protected under the Bankruptcy Code, so if the equity holders believe their interests are
better served with a valuation from the bankruptcy court at fair market value rather than a liquidation
value established through foreclosure, then the goal of serving that interest is appropriate. This is
especially so when, as here, unsecured creditors other than Park Sterling must rely upon the
guarantors for payment. If valuation by this court results in guarantors having less liability to Park
Sterling, then they will be better able to pay other creditors, which is wholly consistent with the
ultimate aims of the Bankruptcy Code
In this case, as in In re Swartville, the court is “satisfied that the debtor’s purpose in filing
the petition was not to abuse the bankruptcy system or impose hardship upon creditors, but rather
to utilize the valuation process available under 11 U.S.C. § 506(b) and surrender property pursuant
to 11 U.S.C. § 1129(b)(2)(A)(iii).” 	Swartville, 2012 WL 112990 at *3. 	The provisions of
§ 1129(b)(2) are available for the debtor’s use, that is precisely what the debtor did, and that
appropriate usage does not support a finding of bad faith.
As the Carolin court observed, the “dangers of overemphasis on particular indicia or patterns,
of engaging in mere indicia-counting, and of forcing particular facts into previously identified
patterns [are] obvious, and must be guarded against.” Carolin, 886 F.2d at 701. 	In this case, it
appears to the court that there may be some indicia-counting going on in the Park Sterling camp,
with each development in the case – particularly those pertaining to guarantors – causing Park
7
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 7 of
12

Sterling to re-examine what it believes the debtor had in mind when the debtor originally filed its
chapter 11 petition.2 While Park Sterling, like any creditor, is wise to stay on its toes and constantly
assess the progress of the case, the facts of this case simply do not support a finding that it was filed
in bad faith, and the cases on which Park Sterling relies are not persuasive.
B. 	Objective Futility
Because it is necessary for Park Sterling as the movant to demonstrate both objective futility
and bad faith, which it cannot do, the court could end its consideration of the motion to dismiss here.
See Carolin, 886 F.2d at 700. However, in the interest of thoroughness, the court also will undertake
the objective futility inquiry.
Park Sterling endeavored to meet its burden of demonstrating objective futility by insisting
that the debtor’s plan cannot provide, to any of its non-insider creditors, value that would otherwise
be lost outside of bankruptcy. Park Sterling Bench Brief in Support of Mot. to Dismiss at p. 3. For
that reason, Park Sterling argued, the case is objectively futile in that it:
Does not create any additional value for the Debtor. The Debtor proposes to fully
surrender its property to Park Sterling, which would leave the Debtor with nothing
2 There is no specific temporal aspect to the court’s assessment of a motion to dismiss under
§ 1112(b), but courts generally take as evident that a debtor’s intent in filing a petition is best
assessed with reference to what that debtor knew and what had already in fact happened, at or prior
to the time of filing the petition. See, e.g., In re Hurt, 369 B.R. 274, 279 (Bankr. W.D. Va. 2007)
(“Carolin Corp. holds that a creditor seeking to dismiss a Chapter 11 case for bad faith must prove
that objective futility and subjective bad faith were present at the filing.”).
Park Sterling itself bases its motion on its assumed motivation of the debtor at the time it
amended its plan, not at the time of the filing of the petition: to “achieve a favorable valuation . . .
for the purpose of attempting to limit (or eliminate) guarantor exposure”: specifically, “[a]fter one
(1) day of appraiser testimony, after realizing it could not confirm a partial dirt-for-debt plan over
Park Sterling’s objection, the Debtor decided to amend its Plan and Disclosure Statement to provide
for a full dirt-for-debt treatment of Park Sterling’s claim and collateral.” Park Sterling’s Mot. to
Determine Classification of Claims at p. 1 ¶ 3.
8
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 8 of
12

to reorganize and no remaining value. 	This is precisely the position the Debtor
would be in were Park Sterling allowed to proceed with its state law rights against
the Debtor’s property, or were this case converted to Chapter 7.
Does not create any additional value for any non-insider creditor. Were this case
dismissed or converted, the tax claim of Brunswick County remains protected and
will be paid first out of any proceeds from the sale of the Property. The Debtor’s
Amended Plan proposes that the unsecured claim of Regions Bank will be paid by
the Debtor’s members, not from the Debtor’s assets. 	Payments from an outside
source are not governed or required by the bankruptcy code. Rather, the treatment
of Regions Bank’s claim is a gratuitous offer made by the Debtor’s members that
could just as well be made in Chapter 7 or following dismissal of this case.
Id. at p. 4-5.
In response, the debtor pointed out that appraisals undertaken by both the debtor and Park
Sterling indicate the existence of an equity cushion in the property, and argued that it “clearly has
a going concern to preserve.” Debtor’s Response to Mot. to Dismiss at p. 2. In the court’s view,
the more compelling factor weighing against objective futility in this case is that the debtor has filed
a plan that could possibly be confirmed as filed, or with reasonable modification. 	See, e.g.,
Swartville, 2012 WL 1129990 *2 (noting that the fact that the debtor’s plan could be confirmed was
a factor “weighing against objective futility”); In re Skeen, Goldman LLP, 2007 WL 4556683 *5
(Bankr. D. Md. 2007) (including the “low probability of a confirmed plan” as a factor supporting
a finding of objective futility under Carolin).
As is discussed in more detail below, the classifications within the debtor’s first amended
plan are proper in that there will be an accepting impaired class (Regions Bank having already filed
an accepting ballot). The guarantors will need to show their ability to pay, but the confirmation
hearing – which is the proper arena in which to resolve that question – has not yet taken place, and
Park Sterling has not shown that the plan cannot be confirmed within a reasonable amount of time.
9
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 9 of
12

There is no basis upon which this court could determine that the debtor’s case is “objectively futile,”
and the court denies Park Sterling’s motion to dismiss on that basis as well.
Park Sterling’s motion included a request for conversion as an alternative to dismissal, but
Park Sterling did not go beyond the bounds of the arguments it offered in support of dismissal.
Those arguments did not establish cause to convert, and there is no indication that the interests of
creditors and the estate would be best served by conversion of the chapter 11 case to a case under
chapter 7.
II. 	Motion to Determine Classification of Claims
Park Sterling moves, in the alternative, for the court to determine that the debtor has
improperly classified a separate class of unsecured claims which would, if properly classified, result
in the non-existence of an accepting class. 	Specifically, Park Sterling challenges the separate
classification of Regions Bank’s unsecured claim in the amount of $80,370.08. For the reasons that
follow, the court determines that the classes designated by the debtor are proper and that
reclassification is not warranted, and the debtor may proceed to confirmation.
Rule 3013 provides that “[f]or the purposes of the plan and its acceptance, the court may, on
motion after hearing on notice as the court may direct, determine classes of creditors and equity
security holders pursuant to §§ 1122, 1222(b)(1), and 1322(b)(1) of the Code.” 	Fed. R. Bankr.
P. 3013. The rule is a “gatekeeping provision,” Park Sterling asserts, which this court should use
to preclude the debtor’s alleged effort to “gerrymander” the general unsecured claim of Regions
Bank and the unsecured deficiency claim of Park Sterling into two separate classes. “There is no
explanation or legitimate justification even offered for this gerrymandering in either the Plan or
Disclosure Statement,” and the “separate classification of the similarly situated, non-insider
10
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 10 of
12

unsecured claim[s] . . . is improper and violates 11 U.S.C.§ 1122 and well-established Fourth Circuit
precedent.” 	Park Sterling’s Mot. to Determine Classification of Claims at p. 2 ¶¶ 9, 7. 	Park
Sterling concludes that the debtor is required to “demonstrate that claims have been classified
separately ‘for reasons independent of the Debtor’s motivation to secure the vote of an impaired,
assenting, class of claims,’” but that the debtor cannot do so. Id. at p. 2 ¶ 8 (quoting Traveler’s Ins.
Co. v. Bryson Props., XVIII (In re Bryson Props., XVIII), 961 F.2d 496, 502 (4th Cir. 1992)).
The court disagrees. Section 1122 prohibits a classification scheme designed to manipulate
voting, but does extend to debtors the discretion to separately classify claims if the classification is
supported by some “legitimate purpose” or features “legitimate differences among otherwise
substantially similar claims.” In re Sea Trail Corp., 2012 WL 5247175 *6 (Bankr. E.D.N.C. 2012)
(quoting In re Somerset Props., SPE, LLC, 2012 WL 3644737 *4 (Bankr. E.D.N.C. 2012) (internal
quotations omitted)). 	The debtor is required to establish that there are meaningful distinctions
between the classes, and legitimate bases upon which to classify the claims separately, and in this
case the debtor has done so. As the debtor points out, the treatments of the claims are different:
The proposed treatment of Park Sterling’s deficiency claim, if any, is amortized over
a shorter period of time [60 months] and paid at the contract rate of interest [5%], as
noted on the claim of Park Sterling. In addition, the Plan provides that one or more
members of the Debtor would provide Park Sterling with collateral to secure the
unpaid balance of the claim if the claim is not paid in full within a year, in effect
allowing Park Sterling’s claim to remain secured. The unsecured claims, however,
which have always been unsecured, are paid over a longer period of time [7 years]
and at a lower interest rate [of 3%].
Debtor’s Response to Park Sterling’s Mot. to Determine Classification of Claims at p. 2 ¶ 	7.
Moreover, Park Sterling is a secured creditor with a right to elect under 11 U.S.C. § 1111(b)(2) to
be treated as fully secured by the debtor, which is a right that Regions Bank does not have. Id. at
p. 2-3 ¶ 9 (citing Matter of Woodbrook Assocs., 19 F.3d 312 (7th Cir. 1994)). While Park Sterling
11
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 11 of
12

may elect not to enforce that right, its decision, which would be based entirely on Park Sterling’s
subjective assessment of its unique business interests, does not invalidate the underlying basis for
the designation. 	Because the debtor’s classification of the unsecured claims is reasonable and
because the debtor has articulated legitimate bases for the classification, Park Sterling’s motion
objecting to the classifications will be denied.
CONCLUSION
Park Sterling’s motion to dismiss or convert was denied on September 6, 2012, for the
reasons set forth above. Because the classification scheme proposed by the debtor is legitimate,
reasonable and nondiscriminatory, Park Sterling’s motion requesting that the court determine the
debtor’s claims classification to be improper is DENIED.
In addition, the debtor’s motion for valuation is ALLOWED, Park Sterling’s motion to stay
entry of any order regarding valuation is DENIED, and the debtor’s objection to Park Sterling’s
withdrawal of its motion is DENIED AS MOOT. The court will, by separate order, determine the
value of Park Sterling’s collateral and set the confirmation hearing.
SO ORDERED.
END OF DOCUMENT
12
Case 11-07628-8-SWH Doc 168 Filed 11/01/12 Entered 11/01/12 14:25:35 Page 12 of
12