REDONDO CONSTRUCTION CORPORATION

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IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF PUERTO RICO
In re: :
:
REDONDO CONSTRUCTION CORP., : Case No. 02-02887(GAC)
:
Debtor : Chapter 11
___________________________________:
DECISION AND ORDER
The debtor filed a voluntary petition under Chapter 11 on
March 19, 2002. On October 8, 2003, the debtor filed a motion for
an order to show cause against Summertime Development Corp.
(“Summertime”) and its president, Ramon Martinez Perez
(“Martinez”), for violation of the automatic stay (dkt. #586). The
debtor claimed that Summertime withheld the sum of $390,579.00 that
it owed debtor for work performed at Summertime Beach Resort (Casa
de Playa) and that these funds are property of the estate. The
Court issued an order to show cause, requiring Summertime and
Martinez to show cause as to why they had willfully violated the
automatic stay (dkt. #632).
Summertime filed an answer to the Order to Show Cause (dkt.
#668). In its motion, Summertime alleges that the debtor did not
comply with its contractual duties by failing to complete any of
the units which it contracted to build. Therefore Summertime
argues that any entitlement to the sums sought is disputed. By
separate motion, on December 1, 2003, Summertime requested leave to
deposit the disputed amounts in court (dkt. #669). The debtor
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filed a motion indicating that it had no objection to the funds
being deposited with the Court (dkt. #676) and the Court granted
Summertime’s request to deposit the funds.
The debtor filed a reply to Summertime’s answer to the order
to show cause alleging that it completed the units that it was
obligated to complete and that Summertime unconditionally agreed to
pay the debtor the sum claimed (dkt. #713).
The Court scheduled a hearing for March 24, 2004 and ordered
the debtor to file an adversary proceeding to seek turnover of
property. On February 9, 2004, the debtor filed an urgent motion
requesting that Summertime be ordered to deposit the amount of
$390,579.00, which Summertime had voluntarily agreed to deposit
(dkt. #742). The Court ordered Summertime to show cause as to why
it failed to deposit the funds (dkt. #743). The debtor also filed
its adversary proceeding on February 9, 2004, requesting the same
relief that it had requested in its motion seeking the order to
show cause.
At the hearing of March 24, 2004, the Court again ordered
Summertime to deposit the funds with the Court within ten days and
to file an informative motion in compliance with the orders to show
cause. Summertime filed a motion for reconsideration of the order
to deposit the funds (dkt. #804). Summertime argued that it
ultimately sold the project that was the subject of this
controversy and that it lost $500,000.00 in anticipated profit due
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to the debtor’s faulty construction. Summertime also indicated
that it received the sum of $588,024.03 at the time of the sale,
which it used to pay suppliers, commissions, cancellation options
and for construction done at the site. Summertime indicated that
the remaining $500,000.00 owed to it from the sale was deferred as
a mortgage note due in 120 days to one year. Summertime further
alleged that the debtor over billed it the amount of $246,478.00
and that it had to spend $130,000.00 to repair the debtor’s
construction faults. Summertime argues that it made the offer to
deposit the funds at a time when it thought it could do so, but
that it is unable to comply at the present time. Summertime
indicates that the disputed amount can be paid when it collects the
$500,000.00 mortgage note.
The debtor responded to Summertime’s motion for
reconsideration with a motion for civil contempt for Summertime’s
failure to deposit the funds (dkt. #811). The Court scheduled a
hearing for April 27, 2004. At the hearing, the Court concluded
that the debtor had a strong possibility of prevailing on the
merits of the dispute and that Summertime ignored the orders of the
Court to deposit the sum of $390,579.00. Instead Summertime sold
the project receiving $250,000.00 as a down payment, $500,000.00 at
the closing and the note payable of $500,000.00. The Court fined
Summertime and Martinez the amount of $10,000.00 and ordered
Summertime and/or Martinez and the Bank & Trust of Puerto Rico
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(“BT”) to deposit the $500,000.00 note payable with the Court until
this matter is decided.
Eurobank, as subsequent holder in interest of the mortgage
note, filed a motion for reconsideration of the Court’s order to
deposit the note (dkt. #842). Eurobank indicates that BT was
subpoenaed to appear at the hearing to produce certain documents
related to the project and all checks issued by BT in reference to
the project. BT’s authorized officer testified and then was
excused. Eurobank argues that BT was not a party to the dispute,
that Eurobank has the sole right to hold the mortgage note until
full payment of the first mortgage, that the Court’s order deprives
Eurobank of property without due process and that the equitable
subordination of Eurobank’s rights requires an adversary proceeding
pursuant to Fed. R. Bankr. P. 7001(8).
Summertime and Martinez also filed a motion requesting that
all proceedings and court orders in connection with debtor’s
request for an order to show cause and to recover property, which
were filed and entered in the legal case, be stricken, vacated and
set aside (dkt. #864). Summertime contends that the Court did not
have jurisdiction to enter orders against it because the nature of
the relief requested by debtor required the filing of an adversary
proceeding.
The debtor responded to Eurobank’s motion for reconsideration
arguing that Eurobank was not denied due process because it
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appeared in court at the hearing of April 29, 2004 (dkt. #913).
Moreover, the debtor argues that Summertime represented to have an
absolute right over the mortgage note and suggested that the Court
could order the deposit of the note as a remedy. The debtor also
argues that Eurobank has failed to establish that it holds a
perfected security interest over the mortgage note. In its prayer
for relief, the debtor requests that the Court deny Eurobank’s
motion and order it to deposit the mortgage note and that the Court
order that all sums deposited in favor of Summertime in an eminent
domain proceeding in local court, be deposited with this Court.
Eurobank filed a surreply (dkt. #925). Summertime filed an
opposition to the debtor’s response to Eurobank’s motion for
reconsideration (dkt. #931). At a hearing held on January 25,
2005, the Court took the matter under advisement.
DISCUSSION
The Court will separately discuss the issues raised by
Eurobank and those raised by Summertime and Martinez. As to
Eurobank, the Court concludes that the order requiring BT to
turnover the mortgage note was entered without due process and
accordingly it will be vacated.
Due process requires adequate notice of any action which may
have a substantive impact on a party’s vested property rights.
Mullane v. Central Hanover Bank and Trust, 339 U.S. 306 (1950).
Moreover, in order to subordinate Eurobank’s rights in the note,
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the debtor was required to file an adversary proceeding pursuant to
Fed. R. Bankr. P. 7001(8).
BT was subpoenaed to appear at the hearing of April 27, 2004
as a witness, not as a party. After BT’s officer testified, the
officer and BT’s attorney were excused from the hearing. The
hearing was scheduled as a hearing on contempt and the debtor never
requested a remedy against BT nor did the debtor present any
evidence to support a position that it has a priority in the note
superior to the rights of BT. Rather, during the hearing to
determine whether it had acted in contempt of Court, Summertime
offered the deposit of the mortgage note as a substitute remedy for
the deposit of the $390,579.00.
The Court understood at the hearing that the note was not
security, but rather was for notarial cancellation. In the motion
for reconsideration, however, Eurobank claims that it has the legal
right to subordinate the mortgage note to all payments it receives
from the sale of the residential units of the project and from any
payment received from independent sources until full payment of all
sums owed to Eurobank and secured by the first mortgage. It also
alleges that it has the sole right to hold possession of the
mortgage note until full payment is made. If these assertions are
true, the order would have the effect of depriving Eurobank of
property without due process. Because Eurobank did not receive
adequate notice that an action could be taken which may have a
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substantive impact on Eurobank’s vested property rights, the order
must be vacated.
The issues raised by Summertime and Martinez are somewhat more
complicated. Their basic position is that the relief ordered, i.e.
the deposit of the $390,579.00 with the Court, required the filing
of an adversary proceeding. They claim that the orders were
entered in the legal case without subject matter jurisdiction.
They also argue that the Court’s order requiring that they pay the
sum of $10,000.00 for contempt of Court is not valid because the
Court is fining them for violation of the automatic stay, which is
not disobedience to a Court order.
As Summertime and Martinez correctly argue, pursuant to Fed.
R. Bankr. P. 7001(1), an adversary proceeding is generally required
to recover money. See also In re Perkins, 902 F.2d 1254, 1258 (7th
Cir. 1990)(orders of bankruptcy and district court vacated where a
turnover action brought by motion should have been brought as an
adversary proceeding); In re Wheeler Tech., Inc., 139 B.R. 235
(B.A.P. 9th Cir. 1992)(debtor’s action to recover property from
creditor inappropriately brought by means of ex parte motion, since
adversary proceeding was required); In re Mayex II Corp., 178 B.R.
464, 467 (Bankr.W.D. Mo. 1995); In re Interpictures, Inc., 96 B.R.
24, 28 (Bankr.E.D.N.Y. 1988). In the present case, the Court has
not decided the ultimate controversy, that is whether the debtor is
entitled to collect the $390,579.00, which is seeks to collect from
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Summertime and Martinez. This matter is being decided within the
context of the adversary proceeding that the debtor filed against
Summertime and Martinez. The matter decided in the legal case was
that, in the interim, Summertime and Martinez would deposit the sum
of $390,579.00 with the Court until the adversary is decided. The
Court also decided that Summertime and Martinez willfully violated
the Court’s order to deposit this sum with the Court and for that
contempt of court, the Court fined them the sum of $10,000.00.
Summertime cites In re Rimsat, Ltd., 208 B.R. 910
(Bankr.N.D.Ind. 1997) and In re Hunter, 190 B.R. 118 (Bankr.D.Co.
1995), for its contention that the debtor was required to file an
adversary proceeding rather than file a motion to hold contempt
proceedings for violation of the automatic stay. As stated by the
Court in In re Rimsat, Ltd, 208 B.R. at 911, “[i]n order to prevail
on a contempt petition, the complaining party must demonstrate . .
. that the respondent has violated the express and unequivocal
command of a court order.” (quoting D. Patrick, Inc. V. Ford Motor
Co., 8 F.3d 455, 460 (7th Cir. 1993)(emphasis original)). As
Summertime is well aware, the Court’s hearing on contempt was not
related to the alleged violation of stay. The contempt hearing, as
stated above, was based on Summertime’s disobedience to the Court’s
order to deposit the funds, thus the cited cases are clearly
distinguishable.
While the debtor initially sought turnover of the funds by way
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of motion, the debtor remedied the procedural defect by filing the
adversary proceeding. The only reason that Summertime and Martinez
were ordered to deposit the sum of $390,579.00 with the Court was
because they filed a motion requesting leave to deposit this sum.
The Court approved the motion and indicated that the Clerk would
hold the funds in deposit. Summertime and Martinez failed to
deposit the funds.
The first hearing scheduled on the matter was scheduled for
March 24, 2004 and in the order scheduling the hearing, the Court
required that the debtor file an adversary proceeding, which the
debtor did on February 9, 2004. At the hearing of March 24, 2004,
the Court ordered Summertime and Martinez to deposit the funds
within ten days. It was not until April 5, 2004 that Summertime
and Martinez filed a motion for reconsideration, informing that
they had sold the project and dissipated the funds, except for the
$500,000.00 mortgage note. Summertime and Martinez indicated that
they sold the project on March 4, 2004, while these matters were
pending. This was the basis for the Court’s finding on April 29,
2004, that Summertime had ignored the Court’s orders to deposit the
funds.
Moreover, while an adversary is generally required to obtain
turnover of property, a party may waive its right to protest the
lack of an adversary proceeding. Thus, the failure to file an
adversary proceeding is not a jurisdictional defect. In re Service
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Merchandise Co., Inc., 256 B.R. 755, 765-66 (Bankr.M.D.Tenn. 2000);
In re Enfolinc, Inc, 233 B.R. 351, 353 (Bankr.E.D.Va. 1999).
Waiver occurs when a party knowingly fails to litigate a Rule 7001
issue that they had the opportunity to litigate. In re Zale Corp.,
62 F.3d 746, 763 (5th Cir. 1995); In re E-Z Serve Convenience
Stores, Inc., 318 B.R. 631, 636 (D.M.D. 2004); In re Zolner, 249
B.R. 287, 292 (N.D.Ill. 2000). Even if a waiver does not occur,
the lack of an adversary proceeding will be deemed harmless error
where the failure to file an adversary proceeding does not result
in demonstrable prejudice. In re E-Z Serve Convenience Stores,
Inc., 318 B.R. at 636. See also In re Cannonsburg Environmental
Assoc., Ltd., 72 F.3d 1260, 1265 (6th Cir. 1996); Trust Corp. v.
Patterson (In re Copper King Inn, Inc.), 918 F.2d 1404, 1406-1407
(9th Cir. 1990); In re Zolner, 249 B.R. 287, 292 (N.D.Ill. 2000);
In re Orfa Corp. Of Philadelphia, 170 B.R. 257, 275 (E.D.Pa. 1994);
In re Lewis, 142 B.R. 952, 955 (D.Colo. 1992); In re Little, 220
B.R. 13, 17 (Bankr.D.N.J. 1998); and In re Vandy, Inc., 189 B.R.
342, 346 (Bankr.E.D.Pa. 1995); In re Command Services Corp., 102
B.R. 905, 908 (Bankr.N.D.N.Y. 1989).
The Court concludes that Summertime waived its right to
protest the lack of an adversary proceeding prior to the Court’s
order requiring it to deposit funds as a provisional remedy.
Summertime offered to deposit the funds and then acted contrary to
the offer by selling the project and dissipating the funds while
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this matter was pending. Summertime was ordered to deposit the
funds or the note on three separate occasions prior to complaining
about the lack of an adversary proceeding. The Court also notes
that the remedy is only provisional and the debtor’s actual right
to obtain the funds is subject to the outcome of the adversary
proceeding filed.
Further, as noted above, the adversary proceeding was filed
prior to the Court’s order requiring Summertime to deposit the
funds with the Court. The orders were entered in the legal case,
but the Court concludes that the failure to enter the orders in the
adversary proceeding rather than in the legal case, was harmless
error because the orders did not result in demonstrable prejudice.
Summertime was notified of the debtor’s motion seeking an order to
show cause and was served with the summons and complaint in the
adversary proceeding prior to being ordered to deposit the funds
with the Court. Prior to the filing of the adversary proceeding,
the debtor’s motion clearly provided Summertime with notice of the
nature of the pending litigation. Accordingly, Summertime’s motion
for relief from the Court’s orders will be denied.
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ORDER
WHEREFORE IT IS ORDERED that Eurobank’s motion (dkt. #842) for
reconsideration of the Court’s order to deposit the mortgage note
shall be, and it hereby is, GRANTED. The order requiring Eurobank
to deposit the note is VACATED, without prejudice to the debtor
seeking this relief in the adversary proceeding.
IT IS FURTHER ORDERED that the motion filed by Summertime and
Martinez (dkt. #864) requesting that all proceedings and court
orders in connection with debtor’s request for an order to show
cause and to recover property, which were filed and entered in the
legal case, be stricken, vacated and set aside shall be, and it
hereby is, DENIED. Summertime and Martinez are granted fifteen
(15) days to comply with the Court’s previous orders to deposit the
sum of $390,579.00 with the Court, noting that it is in reference
to Adv. No. 04-00017, and to pay the $10,000.00 fine previously
imposed by the Court.
SO ORDERED.
San Juan, Puerto Rico, this 3rd day of October, 2005.
/s/ Gerardo A. Carlo
__________________________
GERARDO A. CARLO
Chief, U.S. Bankruptcy Judge
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