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Delaware Bankruptcy Court Denies Emergency Motion to Appoint an Interim Trustee for Gap Period in Involuntary Chapter 7 Case

By Charlene D. Davis

On November 13, 2015, Judge Laurie Selber Silverstein of the United States Bankruptcy Court for the District of Delaware (the “Court”) issued a Memorandum Opinion and Order denying an emergency motion for the appointment of an interim chapter 7 trustee filed by petitioning creditors in a contested involuntary chapter 7 case (the “Emergency Motion”).  In re: Diamondhead Casino Corporation Case No. 15-11647 (LSS).  In denying the requested relief, the Court found that, although there is a likelihood that an order for relief will be granted when the alleged debtor’s motion to dismiss is heard, the petitioning creditors did not demonstrate that a trustee is necessary to preserve the property of or to prevent loss to the estate.

In August of 2000, Diamondhead Casino Corporation (the “Alleged Debtor” or the “Company”) divested itself of its ship-based operations and began focusing on the development of a land-based casino on a portion of 404 acres of undeveloped land in Diamondhead Mississippi (the “Property”).  In early fall 2015,  the Property, including 50 acres recently approved by the Mississippi Gaming Commission for gaming operations, was appraised and valued at $39 million dollars.  The Company does not generate operating revenues and expects continued losses for the foreseeable future.  It is currently in default of obligations owed to the petitioning creditors as well as a $1 million line of credit.

In February 2014, the Alleged Debtor raised $3 million in three tranches (although at least $850,000 was returned).  The private placement memorandum issued in connection with the offering disclosed that the first tranche of funds would be used for (1) closing costs of the issuance; (2) partial payment of amounts owed to the Company’s CEO; (3) general administrative and operating expenses.  Funds were also to be used bring the Company into SEC compliance and to apply for the gaming site approval.  Subsequently in June 2015, a group of shareholders, including one of the petitioning creditors, undertook an unsuccessful consent solicitation to remove and replace the incumbent Board of Directors of the Company.  The involuntary petition was filed on August 6, 2015.  On August 28, the Alleged Debtor moved to dismiss the petition or convert the case to chapter 11.  The Emergency Motion to appoint an interim chapter 7 trustee followed.  The Court conducted an evidentiary hearing on the Emergency Motion on October 16 and 20, 2015.

In the Memorandum Opinion, the Court notes that while an involuntary petition is an extreme remedy, the appointment of an interim trustee, as permitted by Bankruptcy Code section 303(g), is even more extreme.  Case law applying section 303(g) is limited.  The authority that does exist counsels that such a request should only be granted to avoid a substantial risk to the estate.  In a case such as the Company’s, where the Alleged Debtor seeks dismissal, the court must determine, as a preliminary matter, that there is a reasonable likelihood that the order for relief will be entered.

Thus, as a preliminary matter,  the Court applied sections 303(b) and (h) of the Bankruptcy Code to the evidentiary record to conclude that the petitioning creditors debts were not contingent, were not subject to bona fide dispute and satisfied the aggregate unsecured statutory amount.  In addition, the Court found that the Alleged Debtor was not paying its debts as they became due.  The Court also considered evidence relating to, but did not decide on, the Alleged Debtor’s allegation that the involuntary petition had been filed by the petitioning creditors in bad faith; relying instead on a presumption of good faith for purposes of the Emergency Motion.  In view of these determinations, the Court concluded that there is a reasonable likelihood that an order of relief will be entered.

Nonetheless, the Court denied the Emergency Motion on its merits, finding that the petitioning creditors had failed to meet their burden to show that a trustee is necessary in the gap period to preserve property of the estate or prevent loss.  Based on the evidence, the Court found that during the gap period (1) the prime asset of this non-operating Company, the Property, was not going to be sold; (2) the value of the Property will not dramatically decline; and (3) the cash on hand would be depleted with or without an interim trustee.  Finally the Court concluded that petitioning creditors’ lack of trust in management or frustration with lack of progress in development of the Property were insufficient to warrant the appointment of a trustee.

A copy of the Court’s opinion is available here.

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