IN RE: WILLIAM IRA SHAW                CASE NO. 96-51538

UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

LEXINGTON

 

IN RE:

 

WILLIAM IRA SHAW                CASE NO. 96-51538

 

DEBTOR

 

MEMORANDUM OPINION

 

            This case is before the court for consideration of the requests for compensation and reimbursement of expenses of counsel for the debtor/debtor-in-possession, as set out in counsel’s First Interim Fee Application filed October 7, 1998, Second Interim Fee Application filed February 10, 1999, and Final Fee Application filed June 1, 1999.

            Compensation requested in these applications totals $60,511.25.  Counsel received and has been paid a retainer of $1,391.40.  By previous court order counsel has been authorized compensation of $15,162.50, of which $7,720.51 has been paid.  Counsel has been authorized reimbursement of expenses in the amount of $457.18, none of which has been paid.

BACKGROUND:

            According to the records of this court, of which the court takes judicial notice, the debtor, d/b/a Bill Shaw Real Estate and Horse Farm Consultation Service, filed a petition for relief under chapter 7 of the Bankruptcy Code in this court on September 29, 1987, Case No. 87-51021.  He gave as a reason for his bankruptcy the fact he was engaged in divorce proceedings and had experienced a slump in the real estate business.  He received a discharge in bankruptcy on September 12, 1988 from debts, primarily business debts, aggregating in excess of $391,000.  The case was closed in November 1992.

            On July 12, 1993, the debtor, then single, purchased from Shayler Run Development Company a residence on 23.267 acres on Yarnallton Road in Fayette County, Kentucky.  Deed Book 1682, Page 60, Fayette County Clerk’s Office.  At the time of purchase the debtor executed a first mortgage on the property in the amount of $105,000 in favor of State National Bank of Frankfort, Kentucky and a second mortgage in the amount of $35,000 in favor of the seller, Shayler Run Development Company.  On September 14, 1994 the debtor conveyed 12.502 acres of the property to Alvin J. Criswell.  Deed Book 1750, Page 81, Fayette County Clerk’s Office.  Thus, the debtor presently owns the residence and 10.765 acres.

            The debtor filed a petition for relief under chapter 13 of the Bankruptcy Code in this Court on July 26, 1996, Case No. 96-51538.[1]  He indicated he was single at that time, that he was self-employed doing business as Bill Shaw Real Estate and B-S Enterprises.  The schedules to the petition indicated that on February 3, 1995 the debtor granted a third mortgage on his residence to Richard Ransom to secure a loan in the amount of $25,000, and that on June 27, 1995 the debtor granted a fourth mortgage on the property to Kentucky Bank of Paris, Kentucky to secure a loan in the amount of $13,000.

            The schedules to this earlier chapter 13 petition indicated the four mortgage holders were asserting claims against the debtor and his property in a foreclosure action in the Fayette Circuit Court, and that there were local, state and federal tax liens and approximately 10 judgment liens against the property.

            The debtor’s chapter 13 plan filed with this earlier petition proposed payments of $750 per month plus $2,750 quarterly to the trustee to fund the plan.

            The plan proposed direct payments by the debtor of the monthly payments owed to the four mortgage holders on the residence, with the arrearage on the mortgages to be cured through the plan.  The plan also proposed payment in full of unsecured claims totaling approximately $44,000.  The length of the plan was not specified.  The Statement of Affairs accompanying the debtor’s petition showed his income for the first six months of 1996 was only $10,000, although the debtor showed his monthly income in Schedule I to be $4,800 per month and his monthly expenses to be $4,040.  No specific provision was made in the plan for payment of judgment lien claims, except the statement that allowed secured claims were to be paid in full.

            The chapter 13 trustee moved to dismiss the case on the ground the plan was not feasible.

            The debtor filed Second and Third Amended Plans.  The Third Amended Plan provided for payments of $750 per month, plus $2,750 quarterly commencing November 1, 1996, plus a lump-sum payment sufficient to pay out the plan on or before the 36th month of the plan.  Secured claims were to be paid in full.  Unsecured claims were to be paid to the extent of .20 cents on the dollar.  The source of this balloon payment to pay out the plan was to be the sale or refinancing of the debtor’s residence.  This was the plan confirmed by the court on February 21, 1997.

            On June 25, 1997, four months into the plan, the debtor borrowed $25,000 from Geneva Bartley and used the loan proceeds to purchase from the Devereux heirs two tracts of land in all containing 43 acres, now known as the Farms at Avon.  This property, also identified as 5323 Briar Hill Road, Lexington, Kentucky, was conveyed to the debtor on or about August 1, 1997.  On that date the debtor executed a mortgage on the property in the amount of $202,500 in favor of the sellers, the Devereux heirs.  The debtor did not record the deed from the Devereux heirs conveying him title to the property, possibly because he was aware the property would become encumbered by tax and judgment liens upon recordation of the deed.  On September 9, 1997 the debtor borrowed an additional $25,000 from Geneva Bartley for repairs on the house on this property.  Ms. Bartley obtained the money to make this loan by cash withdrawals on four of her credit cards.  See Proof of Claim No. 25 in Case No. 96-51538.

            The debtor did not obtain permission of the chapter 13 trustee or the court to borrow $50,000 from Ms. Bartley, or to incur the $202,500 debt to the Devereux heirs for the purchase of the 43 acres from said heirs.

            A debtor engaged in business is subject to the limitations on a trustee. 11 U.S.C. 1304(a).  It is a stretch to think the debtor could engage in transactions by which the debtor incurred an additional $252,500 in debt without approval of the chapter 13 trustee and the court.

            The debtor ceased making payments to the chapter 13 trustee in October 1997.  Following a hearing held on January 13, 1998, the trustee recommended dismissal of the case.  An order of dismissal was entered January 20, 1998.  However, the case remained open for receipt of the chapter 13 trustee’s report and final accounting.  The report shows the debtor paid into the plan $20,500, most of which was disbursed in payment of local and IRS tax claims.  The IRS was paid $16,756.94 of the amount paid by the debtor to the trustee.  The trustee filed his report and final accounting on June 22, 1998.  The case was closed on October 16, 1998.

            During the administration of the case the IRS through the U.S. Attorney on February 18, 1997 moved for an order requiring the debtor file Form 1040, U.S. Individual Tax Return for the taxable year ended December 31, 1995.  The court sustained the motion and on February 21, 1997 ordered the debtor to file a return for 1995 and to file all federal tax returns and to pay taxes as they become due.  The record in the case presently before the court indicates the debtor failed to comply with this order.

            Thus, when the present case was commenced as a chapter 13 case on April 29, 1998, the debtor was a debtor in a prior pending chapter 13 case in which he had defaulted on payments under the plan.

            The plan filed by the debtor when he commenced the present case as a chapter 13 case was similar to the plan on which he had defaulted in the prior pending chapter 13 case.  The plan proposed payment to the trustee of $750 per month, plus $2,750 quarterly beginning August 1, 1998, but the sources of funds to make these payments is different.

            The debtor no longer proposes to sell or refinance the indebtedness on his residence to raise funds to pay his creditors.  Instead, he proposes to sell the 43-acres known as the Farms at Avon.  He has apparently subdivided the property into four tracts, and proposes to sell the tract on which a residence is located, and to sell three approximately 10-acre unimproved tracts.  According to Schedule A to the chapter 13 petition the debtor holds an unrecorded deed in fee to this property.  It has never been clear to the court how the debtor might sell this property privately, free and clear of liens which will attach to the property, once the deed to the debtor is recorded, or why the debtor, because he is a realtor, should be entitled to a commission on the sale of property which he owns.  But such was the scenario proposed in the debtor’s chapter 13 plan and the more elaborate subsequent chapter 11 plan.

            Apparently, in April 1997, while a debtor in the prior chapter 13 case, the debtor started operating a bed and breakfast business in his residence at 1201 North Yarnalton Road, from which he derives some income.  The debtor is single.  It is not at all clear how a single debtor might operate a bed and breakfast business, function as a realtor, as a builder engaged in horse farm construction leasing and sales, and care for horses which he proposes to board on 10 acres of land.  The budget of the debtor, as set out in Schedules I and J to the petition, makes no provision for payment of wages to anyone to assist the debtor in these matters.

            Schedule I to a chapter 13 petition specifies a debtor with regular income from the operation of a business or profession or farm shall attach a detailed statement with respect to such income.  The debtor did not provide such a detailed statement with either of his chapter 13 petitions, and has not provided any information of this nature since opting to convert the present case to a case under chapter 11 of the Bankruptcy Code.

            The debtor has not filed State or Federal income tax returns for 1995, 1996 or 1997, so there is no Schedule C for the court or creditors to examine for information with respect to the debtor’s profit or loss from business operations.

            In Schedule J to both chapter 13 petitions the debtor allocates $1,325 per month for payment of real estate and income taxes, but the record in the case indicates the debtor did not pay and has not paid the real estate taxes on his residence or income taxes for 1995, 1996 and 1997, and that he owes approximately $65,000 in back taxes, penalties and interest for 1990, 1992 and 1994.

            The debtor’s total indebtedness as listed in the prior chapter 13 case was approximately $250,000, compared to approximately $1.3 million in the present case.

            Not surprisingly the chapter 13 trustee moved to dismiss the debtor’s new chapter 13 case on the ground the debtor’s unsecured debt exceeded the limit specified in title 11 U.S.C. 109(e).  By order entered July 7, 1998 herein the court allowed the debtor 15 days within which to convert the case to a case under chapter 7, otherwise the case would be dismissed.

            Instead, counsel for the debtor, on July 13, 1998, requested in the debtor’s behalf that the debtor be permitted to convert the case to a case under chapter 11 as permitted by title 11 U.S.C. 1307(d).

            The chapter 11 plan proposed by the debtor is more detailed than the chapter 13 plan, but is less feasible than the chapter 13 plan.

            Under the chapter 11 plan, as under the chapter 13 plan,  the debtor is to retain rather than sell his residence and is to fund the plan in part from earnings from the operation of a 3-5 bedroom bed and breakfast.  The chapter 11 plan proposes sale of the unsold tracts of the Farms at Avon property and use of the net proceeds essentially for the benefit of the debtor – to pay him a real estate commission on each sale, to make the $1,000 monthly and $3,000 quarterly payments initially under the plan, to cure the delinquencies on the four mortgages on his residence, to pay his attorney fees, and to pay other administrative expenses of the chapter 11 proceeding.

            In the prior chapter 13 case and in this case the debtor does not list ownership of a motor vehicle, although he lives in a rural area and is engaged in business as a realtor.  However, after this case was converted to a case under chapter 11 and a committee of unsecured creditors was appointed, at a deposition scheduled by counsel for the creditors’ committee, the debtor testified that in October of 1997, which was approximately the time he defaulted on the plan in his prior chapter 13 case, he entered into an arrangement with Lynn McMillian, who was assisting him in the bed and breakfast operation at his residence, whereby she leased a truck for him to use.  She was obligated on the lease payments and also for the insurance on the vehicle.  She also took draws on a credit card to make loans to the debtor.  He started paying her $413 per month which she was to use for the lease payments, to pay for the insurance on the vehicle and possibly to repay some of the amount he owed her.  She is listed in the schedules to the debtor’s petition as being owed $8,000.  However, she has filed a proof of claim for $9,400 for loans to the debtor in March and August of 1997, which was while the debtor’s prior chapter 13 case was pending.  The proof of claim which Ms. McMillan filed on June 4, 1998 lists her address as 1201 N. Yarnallton, Lexington, which is the same as the debtor’s address.  According to the debtor Ms. McMillian left in June of 1998 to obtain employment because she needed money to pay her debts.

            This $413 monthly payment for use of the leased motor vehicle was not included in the debtor’s budget when he filed the present case.  The budget listed an amount of zero for automobile expenses.  When this expense is included in the debtor’s monthly expenses, his income, in excess of expenses, is reduced from $750 to $337 per month.  The court also notes that the food expense of $350 per month is only $25 per month more than listed in his prior chapter 13 case before he started the bed and breakfast operation.  Apparently the bed and breakfast guests are not well fed.

            Against this background, upon conversion to chapter 11, the debtor, by counsel, proposed a plan whereby he would retain his residence, now named Halifax Farm, pay to his counsel as disbursing agent $50,000 on or before six months after confirmation of the plan and thereafter make payments of $1,000 per month plus $2,000 per quarter or $20,000 per year for 72 months, plus a $10,000 balloon payment at the end of the term of the plan or a total of $200,000.[2]

            The source of the $50,000 initial payment was the proceeds of sale of the four tracts comprising The Farms at Avon.  The Disclosure Statement accompanying the plan indicates that the proceeds of sale would be applied in reduction of the debtor’s payments under the plan and to cure arrearage due secured creditors.  The net amount anticipated to be received from the sale of The Farms at Avon, after satisfaction of the $208,000 mortgage plus accrued interest owed to the Devereux heirs, and administrative expenses, is not specified.  Apparently, payment for some of the tracts will be partly in cash and partly in the form of notes secured by a mortgage or mortgages.

            The source of payment of the $1,000 monthly payments and $2,000 quarterly payments under the plan is not clear.  In addition to these payments the debtor proposes to make direct payments to holders of mortgages and liens on his residence in the aggregate amount of $3,058.04 per month until the arrearages on the four mortgages on his residence are cured and thereafter at the rate of $1,829.04 until the judgment and tax liens on the residence are paid off, and thereafter at the rate of $1,229.04 per month as mortgage payments on the four mortgages.  Thus, the initial payments which the debtor would be required to make commencing six months after confirmation of the plan aggregate $4,058.04 per month plus $2,000 quarterly.  Obviously, the debtor would not be able to make these payments, unless it is contemplated that the proceeds from the sale of The Farms at Avon be used for this purpose until that source of funds is exhausted.

            The record indicates the debtor had not filed Federal or State income tax returns for the taxable years ending 1995, 1996, and 1997 when he commenced the present case as a chapter 13 case on April 29, 1998.  In its proof of claim the IRS estimated the debtor’s tax liability as $18,000 for each of those years, apparently basing this estimated liability on the debtor’s tax liability of $17,546.66 for 1994.

            In his deposition given January 25, 1999, the debtor testified his adjusted gross income for 1993 was $18,006.30.  His adjusted gross income for 1994 was $89,524.74.  However, that was the year he sold off 12.502 acres of the 23.267 acres of the property on Yarnallton Road where he resides.  According to his testimony he received $142,500 for the 12.502 acres.  Apparently some of the sale proceeds were used to reduce the first mortgage indebtedness of $105,000 owed to State National Bank of Frankfort and the second mortgage indebtedness to Shayler Run Development.  The debtor showed a taxable gain of $76,189.95, which accounted for most of his adjusted gross income for 1994, indicating he had only a small amount of taxable income from other sources.  His income for 1994 appears to have been $67,153.30, less expenses or losses of $55,176.76, or about $12,000.

            The debtor’s adjusted gross income for 1997 was $2,266.  The 1997 Federal income tax return shows gross receipts of $215,873 and cost of goods sold of $178,642.  According to the testimony of the debtor much of the cost of goods sold was for the purchase of materials for construction of the bed and breakfast he uses as a residence.[3]  This construction involved improvement of the existing residence on the debtor’s property.  In any event it would appear that deducting from income the cost of goods purchased for improving one’s residence is an impermissible deduction.  In a separate Schedule C to his 1997 Federal income tax return the debtor indicated his gross income from operation of the bed and breakfast during 1997 was $5,686.

            The debtor testified that his gross income from operation of the bed and breakfast during 1998 was approximately $17,000.  There would have been no net income considering the cost of servicing the indebtedness on the debtor’s residence in which he operates this business.

            The Disclosure Statement accompanying the debtor’s First Amended Plan states the debtor has operated a successful construction business specializing in house-barn combinations.  The construction business entered into approximately $250,000 in cost plus 20% contracts in 1996 and $100,000 at cost plus 15% in 1997.  However, we now know the debtor’s adjusted gross income for 1997 was only $2,266, and he apparently has no construction contracts in progress at the present time.

            We also know that The Farms at Avon property was acquired through an unauthorized post chapter 13 petition loan from Ms. Bartley, and the bed and breakfast operation during 1997 was funded through unauthorized post chapter 13 petition loans from Ms. McMillian, and that the latter is obligated on the lease of a truck which the debtor uses for transportation.

            This debtor hardly merits characterization as a “highly successful” businessman and real estate developer.

            There was little likelihood unsecured creditors would ever benefit from the proposed chapter 11 plan, because the past record of the debtor indicates he has not been successful in his business undertakings.  His business operations appear to have been funded by unpaid loans and by nonpayment of taxes, contractors, and suppliers of materials.  The record in the debtor’s prior chapter 13 case shows he was deeply in debt before he undertook the construction project for the Eckers, the principal creditors in the present case.

            The court does not subscribe to the view that counsel for a debtor in possession must pursue diligently client’s business judgment even though it is obvious the client’s business judgment is totally self-serving.  Counsel must constantly remind a debtor in possession that a debtor in possession functions as a trustee for the benefit of creditors generally.

            On the facts of this case the court will reluctantly award counsel for the debtor in possession additional compensation of $5,000 for their services in this case bringing the total allowance to $20,162.50, of which $7,720.51 has been paid, and will approve

reimbursement of expenses in the amount requested by counsel for the debtor/debtor in possession.

            Dated:

                        By the court –

 

                        _______________________________
                        JOE LEE, U.S. BANKRUPTCY JUDGE

 

Copies to:

 

Philip Hanrahan, Esq.

John Morgan, Esq.

Phillip M. Moloney, Esq.

J. Gregory Troutman, Esq.

David Middleton, Esq.

Anna C. Johnson, Esq.

U.S. Trustee

 


UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

LEXINGTON

 

IN RE:

 

WILLIAM IRA SHAW                CASE NO. 96-51538

 

DEBTOR

 

 

 

 

ORDER

 

            In conformity with the memorandum opinion of the court this day entered, IT IS ORDERED that the applications for fees as stated in the memorandum opinion are granted to the extent that counsel for the debtor in possession is awarded additional compensation of $5,000 for services in this case for a total allowance of $20,162.50, of which $7,720.51 has been paid, and expenses in the amount requested.

            Counsel for the debtor in possession, Philip L. Hanrahan, is directed to submit an order to the court setting out specific amounts.

            Dated:

                        By the court –

 

                        ________________________________
                        JOE LEE, U.S. BANKRUPTCY JUDGE

 

Copies to:

Philip L. Hanrahan, Esq.

John Morgan, Esq.

Phillip M. Moloney, Esq.

J. Gregory Troutman, Esq.

David Middleton, Esq.

Anna C. Johnson, Esq.

U.S. Trustee



[1]  As noted in an accompanying opinion this case was filed two days after the debtor entered into a Retainer Agreement with Manfred and Cherie Ecker for construction of improvements on their farm.

[2] The plan would have to continue for 84 rather than 72 months to pay $200,000.

[3]  The debtor was expending funds for improvement of his residence while his property was in foreclosure and while he was in default in payments called for by his chapter 13 plan.