IN RE: Sacks Weston LLC (2024)

Chapter 11

ORDER DISMISSING CASE

AND NOW, upon consideration of Creditor Virage SPV 1 LLC (“Virage”)’s Motion to Dismiss the Debtor's case pursuant to 11 U.S.C. § 1112 (doc. # 124, the “Motion”), the Debtor's Objection to the Motion (doc. # 132), Virage's Response thereto (doc. # 133), and the parties’ arguments at a hearing held April 10, 2024, it is hereby ORDERED that the Motion is GRANTED and the Debtor's case is DISMISSED. *

*END NOTE

On August 25, 2023, Sacks Weston LLC (the “Debtor”) filed for Chapter 11 relief under the Bankruptcy Code. The Debtor is a law firm which specializes in class action litigation and its revenue is primarily derived from contingency fees earned from its cases. Doc. # 142, April 10, 2024, Hearing Transcript (“Tr.”) at 40-41. Sacks Weston P.C. is the sole member of the Debtor, and the Debtor's principals, Andrew Sacks and John Weston (collectively the “Principals”), are equal shareholders of the corporation. Id. at 41. While both licensed attorneys, only Weston handles the Debtor's substantive legal work. Id. at 42-43; 70. Sacks, on the other hand, handles no substantive legal work but is solely responsible for generating business for the Debtor. Id. at 43-44; 70.

In order to finance the Debtor's operations prior to earning its contingent fees, the Debtor sought the support of several litigation funders. Id. at 47-49. On June 5, 2017, the Debtor executed a loan agreement with litigation funder Virage SPV 1 LLC (“Virage”) which consolidated two prior Virage-affiliated loans and advanced new funds to the Debtor.¹ Doc. # 124, Ex. 5. The loan provided Virage a security interest on the accounts of the Debtor's contingent fee cases and any proceeds arising from those accounts. Id.; Tr. at 47-48. Virage's lien encumbers fees earned on cases retained by the Debtor pre-petition. See Doc. # 106 (ordering that “§ 552 does not extinguish or affect the pre-petition liens that Virage holds on the Debtor's pre-petition lawsuits.”). As a result of the Debtor's inability to pay its obligations as they came due, Virage filed a proof of claim in this case in the amount of $14,498,570.08.² Proof of Claim # 10-1.

On February 21, 2024, the Debtor filed its proposed Plan. Doc. # 109. The Debtor's plan divides claimants into six (6) classes: three (3) classes bear importance on this decision. Id. The first class (Class 1) provides for Virage's secured claim. Id. The third class (Class 3) bifurcates Virage's claim into an unsecured deficiency claim. Id. To the extent the amounts are still owed to Virage following the conclusion of the collateralized, pre-petition cases, the plan provides an unsecured deficiency claim for Virage— distinct from other general unsecured claims (“GUC”). Id. The fourth class (Class 4) consists of all other GUCs. Id. Litigation funder Jordan Litigation Services LLC (“Jordan”) holds the largest Class 4 claim. Id.

The Plan discloses limited information regarding its execution and funding. The Debtor submits that it will fund its plan via three (3) means: (1) the Debtor will continue to work on its pre-petition cases which will, in part, pay Virage; (2) the Debtor will retain new post-petition contingent fee cases; and (3) the Principals will contribute $75,000.00 for the benefit of the Debtor's GUCs and at least $150,000.00 toward the satisfaction of admin expenses.

Prior to confirmation or approval of the Debtor's disclosure statement, Virage moved to dismiss the Debtor's case pursuant to 11 U.S.C. § 1112, and for relief from the automatic stay. Doc. # 124.³ Virage argues that there is “cause” to dismiss because the Debtor: (1) filed its petition in bad faith; (2) experiences continuing loss to or diminution of the estate and an absence of a reasonable likelihood of rehabilitation; and (3) will not be able to propose a confirmable plan within a reasonable time because it cannot overcome the objections of its two largest creditors and its plan fails to adhere to the statutory requirements of 11 U.S.C. § 1129. Id.; Tr. at 7-23. The Debtor argues that its petition was filed in good faith because the Debtor experienced significant financial restraints and obligations at the time of its filing. Doc. # 132; Tr. at 54-57. The Debtor further argues that it proposed a viable plan of reorganization because the Debtor has retained new, post-petition contingent fee cases and that any defects to its plan are curable. Id.

Based on the following, I find it is in the best interest of the creditors and the estate to dismiss the Debtor's case for “cause.”⁴

* * * *

The court may, upon request of a party-at-interest, dismiss or convert a Chapter 11 debtor's case for “cause.” 11 U.S.C. § 1112(b)(1). The Bankruptcy Code does not define “cause,” however, § 1112(b)(4) provides the court with a nonexhaustive list of circumstances warranting dismissal for “cause.” The court is not limited to the list in § 1112(b)(4) and may consider other circumstances which constitute cause. In re Brown, 951 F.2d 564, 572 (3d Cir. 1991). The movant bears the initial burden of showing “cause” exists to dismiss the debtor. 7 Collier on Bankruptcy P 1112.04 (16th 2024).

* * * *

A filing not in good faith may constitute “cause” to dismiss under § 1112(b). In re LTL Mgmt., LLC, 64 F.4th 84, 100 (3d Cir. 2023); In re SGL Carbon Corp., 200 F.3d 154, 160 (3d Cir. 1999). Once a lack of good faith is at issue, the burden is on the debtor to show the filing was made in good faith. LTL Mgmt., 64 F.4th at 100. Whether good faith exists is a fact intensive inquiry that requires the court to look at the totality of the circumstances. In re Integrated Telecom Express, Inc., 384 F.3d 108, 118 (3d Cir. 2004). The Court must assess where the “petition falls along the spectrum ranging from the clearly acceptable to the patently abusive.” Id.

Accordingly, the court must undergo a two-part inquiry: “(1) whether the petition serves a valid bankruptcy purpose ․ and (2) whether the petition is filed merely to obtain a tactical litigation advantage.” LTL Mgmt., 64 F.4th at 100 (citing Integrated Telecom, 384 F.3d at 119-20). A valid bankruptcy purpose requires the debtor to have experienced some degree of financial distress at the time of its filing. LTL Mgmt., 64 F.4th at 101. Where a debtor's filing serves only to create a litigation advantage, “a forum shopping device[,] and/or to resolve what is essentially a two-party dispute” the court may find petition was not filed in good faith. In re Stingfree Techs., Inc., 2009 Bankr. LEXIS 3023, at *31 (Bankr. E.D. Pa. Feb. 4, 2009).

* * * *

There is “cause” to dismiss when the debtor suffers “substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation.” 11 U.S.C. § 1112(b)(4)(A). First, the court assesses whether the debtor has suffered or continues to suffer negative cashflow and an inability to pay its obligations as they come due. In re Gateway Access Solutions, Inc., 374 B.R. 556, 564 (Bankr. M.D. Pa. 2007); see also In re Stream TV Networks, Inc., 2024 Bankr. LEXIS 25, at *84 (Bankr. E.D. Pa. Jan. 5, 2024) (noting the court must make a full evaluation of the present condition of the estate). Second, the court must determine whether the likelihood of the debtor's rehabilitation given the evidence at trial. Gateway, 374 B.R. at 562. The relevant inquiry is whether the debtor's business prospects will “put [the debtor] back in good condition; re-establish[ed] on a firm, sound basis.” In re TMT Procurement Corp., 534 B.R. 912, 918 (Bankr. S.D. Tex. 2015); see also In re Mazzocone, 183 B.R. 402, 412 (Bankr. E.D. Pa. 1995), aff'd, 200 B.R. 568 (E.D. Pa. 1996), (“[w]hen a Chapter 11 debtor has no intention or ability to reorganize or perform its own liquidation or otherwise fulfill pertinent bankruptcy obligations ․ a debtor [should] not be permitted to remain in bankruptcy ․ to enjoy the protections of the automatic stay.”).

* * * *

“Cause” also exists if there is not “a reasonable possibility of a successful reorganization within a reasonable period of time.” In re Am. Cap. Equip., LLC, 688 F.3d 145, 162 (3d Cir. 2012) (citing Brown, 951 F.2d at 572); In re Taggart, 2024 U.S. App. LEXIS 4765, at *4 (3d Cir. Feb. 29, 2024) (citations omitted). A determination of “reasonable time” depends on the facts of the case. Am. Cap., 688 F.3d at 162. However, where it becomes apparent the debtor is no longer a going concern and there are no reasonable prospects of confirming a plan, it is futile to let a debtor reap the continuing benefits of Chapter 11 relief. In re DCNC N.C. I, L.L.C., 2009 U.S. Dist. LEXIS 93046, at *16-17 (E.D. Pa. Oct. 5, 2009).

* * * *

Virage makes three (3) broad arguments in its motion to dismiss. First, Virage argues the Debtor filed its petition in bad faith. Doc. #124 Tr. at 13-16, 18-20. Relying on the fourteen (14) bad faith factors enumerated in In re SB Properties, Inc., 185 B.R. 198, 204-05 (E.D. Pa. 1995), Virage cites the Debtor's alleged pre-petition misconduct and misuse of cash collateral which resulted in certain state court actions against the Debtor. Virage submits the Debtor is not a going concern and its filing serves no value to its creditors. Among other reasons, Virage argues the Debtor used its petition as a means to evade state court orders, forum shop, and create what is essentially a two-party dispute between itself and Virage via this bankruptcy case. Id.

Second, Virage argues the Debtor experiences continuing loss to the estate and is incapable of rehabilitation. Virage avers the Debtor has suffered significant financial loss during the bankruptcy. Since the petition date, the Debtor expends $22,180.00 per month in operating expenses, while it has only generated $11,747.00 in revenue from its work on its contingent fee cases.⁵ Virage also contends the Debtor has been unable to generate revenue for years and the speculative nature of unretained contingent fee cases are an improbable means to generate future revenue. Tr. 8-9. As a result, Virage argues the Debtor's proposed plan provides no basis for the Debtor's rehabilitation of the Debtor's business.

Third, Virage argues the Debtor's proposed plan is patently unconfirmable and, therefore, the Debtor will be unable to confirm a plan in reasonable time. Docs. # 124, 133; Tr. at 10-13, 18. Virage avers the Debtor discloses no post-petition work, will have no operational business following Weston's retirement, and impermissibly gerrymanders Virage's deficiency claim. Id. Virage further submits the plan fails to comply with the statutory confirmation requirements of 11 U.S.C. § 1129.

The Debtor responds that the petition was filed in good faith and due to debilitating financial distress.Doc. # 132; Tr. at 26-29, 53-57. The Debtor submits it experienced a significant reduction in working capital following a state court order requiring the Debtor to deposit 60% of its available funds into escrow. Tr. at 27, 49, 88. As a result, Debtor avers it maintained enough cash on hand to operate for one and a half to two months. Tr. at 27-28, 53-54. The Debtor further submits it had little to no ability to pay off the 22.5-27.5% per annum interest on Virage's loan and reasonably believed prior to its filing that 11 U.S.C. § 552 would cut-off Virage's security interest for post-petition fees earned on pre-petition cases encumbered by Virage's lien. Tr. at 54; but see doc. # 106 (order denying the Debtor's § 552 argument). Accordingly, the Debtor asserts that it had no reasonable possibility to fulfill its obligation absent Chapter 11 relief. Doc. # 132; Tr. at 57.

The Debtor further argues that its proposed plan is feasible and that it has presented viable means to fund the Plan. Doc. # 132; Tr. at 25, 62-63, 65-66. The Debtor submits it may earn between $2,600,000.00 to 3,600,000.00 in contingency fees for pre-petition cases. Tr. at 59; Debtor's Ex. # 6. Despite Weston's intention to retire, the Debtor further submits it has and will continue to retain new post-petition contingent fee cases. Tr. at 62-64. The Debtor also proposes that the Principals’ cash infusions are a form of guaranteed payment to general unsecured creditors. Doc. # 132. Moreover, the Debtor argues it appropriately classified Virage's unsecured deficiency claim because Virage may collect on its claim from the principal-guarantors of the loan, and therefore, there is a rational basis for its classification. Id.; Tr. at 119-21.

* * * *

I find the Debtor filed its petition in good faith because it had a valid bankruptcy purpose at the time of its filing. See LTL Mgmt., 64 F.4th at 102 (the debtor must “face[ ] the kinds of problems that justify Chapter 11 relief.”); SGL Carbon, 200 F.3d at 164 (the need for Chapter 11 relief must be apparent). The Debtor was indisputably insolvent on its petition date. In light of the state court orders, had the Debtor not filed, it would have had $40,000.00 in liquid capital with monthly expenditures ranging from $20,000.00 to $30,000.00. Tr. at 27, 53. Facing such financial constraints, the Debtor was on its last legs. This was not the Debtor's only hinderance, as its assets were a fraction of its $15,697,632.07 in liabilities owed to Virage, among other creditors.

The nature and extent of Virage's loan placed the Debtor under significant financial distress. There was likely no plausible means to repay the exceedingly high interest on Virage's loan—let alone the principal balance. Because the interest rate on the loan exceeded the Debtor's revenue, the Debtor was trapped. Assuming arguendo the Debtor earned the maximum expected return on its pre-petition contingency fees, the Debtor would still be $10,896,820.80 shy of satisfying Virage's claim. See Defendant's Ex. 6. Further, I find the Debtor maintained a colorable argument—at the time of its filings—that 11 U.S.C. § 552 would cut-off Virage's security interest in any contingent fees earned post-petition.

Because there was a valid bankruptcy purpose for the Debtor's filing, I need not decide whether the Debtor's petition sought to achieve a tactical litigation advantage. See LTL Mgmt., 64 F.4th at 110 n.19 (refusing to address whether a tactical litigation advantage exists after finding a lack of a bankruptcy purpose); see also In re AIG Fin. Prods. Corp., 651 B.R. 463, 473 (Bankr. D. Del. 2023) (declining to rule on the second prong where the Debtor filed its petition with a valid bankruptcy purpose).

* * * *

I find that there has been a continuing loss to the estate that is likely to continue, and that the Debtor will not be able to successfully reorganize in a reasonable amount of time and, as a result, “cause” exists to dismiss the Debtor's case under § 1112. See Am. Cap., 688 F.3d at 162; Gateway, 374 B.R. at 562-64.

Moreover, the Debtor's financial decline is likely to continue. See Docs. # 56, 71, 78, 88, 97, and 166 (collectively the “monthly operating reports” or “MORs”). At the time of the Debtor's filing, the business maintained $115,742.92 in assets.⁶ Doc. # 15, Sch. A. In a five (5) month span, the Debtor's monthly operating report indicates the Debtor now maintains assets of $86,782.00 (a 25.10% decrease). Doc. # 166. Over the same period, total disbursements have outpaced receipts by $11,717.00. Id. Notwithstanding the Debtor's inability to generate a profit, the Debtor has received—at most—$35,588.00 in a given month. Doc. # 88. Unless the Debtor realizes the value of its contingent fee cases, and generates new cases, it is hard to envision how the Debtor's slow financial decline won't continue.

A successful reorganization cannot rely on contingency fees earned through speculative, unretained post-petition litigation. While such litigation is not the only means of funding the Debtor's plan, the plan is dependent upon successful litigation that is possible, but not reasonably likely. Docs. # 109, 110. The Debtor has engaged in de minimis post-petition work and presented no material evidence it has made or will make meaningful efforts to retain post-petition contingent fee cases. Id.; Tr. at 62-63, 67-69. The Debtor in essence suggests it be afforded Chapter 11 protection while it is given extensive time to seek out contingent fee cases that may or may not come into being. See Tr. at 62 (speculating the principal will “work his magic” to retain new cases) (emphasis added). In sum, the Debtor proposes a plan with no probable sources of funding other than the pre-petition cases encumbered by Virage's lien. Docs. # 109, 110.

Strikingly, over the seven-month life of this case, the Debtor retained two (2) cases of nominal value. Weston—the Debtor's only practicing attorney—acknowledged he himself is not handling the two post-petition cases and holds little knowledge regarding future cases. Tr. at 69. Capital contributions from the Principals cannot cure such defects to the feasibility of the Debtor's proposed plan. Accordingly, I will not keep creditors “on-hold” while the Debtor takes months, if not years, to retain and eventually earn contingent fees. See In re Calvanese, 169 B.R. 104, 107-08 (Bankr. E.D. Pa. 1994) (the court will not tolerate “speculative ventures which place all the risk on the respective secured creditors, and, therefore, are not feasible.”).

The Debtor is not a going concern, and its proposed plan will not maximize the value of the estate. See In re 15375 Mem'l Corp., 589 F.3d 605, 619 (3d Cir. 2009) (finding the debtor did not maintain a going concern where it had no employees, office, or business other than the handling of certain litigation). No viable business continuity plan has been presented to the Court in light of Weston's eventual retirement. Neither the proposed plan nor the disclosure statement address who will continue to litigate the Debtor's pre and post-petition cases after Weston's departure. Tr. at 70-73. Although Sacks is licensed to practice law in the Commonwealth of Pennsylvania, it is the Debtor's position that it would need to hire additional attorneys to operate after Weston's departure. Id. at 71. However, the Debtor acknowledges it cannot afford to hire such attorneys. Id. The Debtor maintains minimal liquid assets and neither the Debtor nor its members hold sufficient assets to distribute to its creditors unless the Debtor retains lucrative post-petition cases. Although it is early in this case and confirmation is not presently before me, I find that Debtor's chances of proposing a confirmable plan within a reasonable time to be exceedingly low. Currently, Debtor's plan relies upon a classification of claims which bifurcates the claim of its largest creditor, Virage, by placing its secured claim in Class 1 and its, as yet, undetermined unsecured deficiency claim, in Class 3. Doc. # 109. The other GUCs are placed in Class 4. Id. Virage has argued that such a classification constitutes impermissible gerrymandering by the Debtor in an attempt to create an impaired class of GUCs who could accept the plan. Doc. # 124; Tr. at 12-13, 22. Such treatment, Virage argues, is precluded by Third Circuit precedent. See John Hancock Mut. Life Ins. Co. v. Route 37 Business Park Assocs., 987 F.2d 154, 158 (3d Cir. 1993).

Debtor argues that the existence of third party guarantees on the Virage loan creates enough of a dissimilarity from the other GUCs to make the separate classification permissible. Tr. at 120-21. The Debtor asks this Court to be guided by the reasoning set forth by the Ninth Circuit Bankruptcy Appellate Panel in In re Loop 76, LLC, 465 B.R. 525 (2012). Id.

Unfortunately for the Debtor, there is another qualifying factor for the Court to consider in this case that creates an even larger obstacle for debtor to propose a confirmable plan. Assuming arguendo that I allow the separate classification as the Debtor requests, I fail to see how debtor can achieve the acceptance of an impaired class as required by 11 U.S.C. § 1129(a)(10). Virage has indicated it will not vote in favor of the plan. Id. at 8. Likewise, Jordan, the largest GUC in Class 4, has joined Virage in this motion to dismiss and will not support the plan. Id. at 8, 23. Jordan holds a claim which equals sixty percent (60%) of the total claims in Class 4. Doc. # 109. Without the support of this claimant, the Debtor will not be able to achieve acceptance of the plan by Class 4 and the hope of confirming a plan is bleak. The overwhelming sentiment of impaired creditors is that the Debtor's reorganization serves no legitimate purpose.

While the Debtor has made a valiant effort to demonstrate its commitment to reviving its business, it has failed to show a proposed plan of reorganization might be confirmable after further negotiations and restructuring. Based on the foregoing, I find “cause” to dismiss the Debtor's case under § 1112.

FOOTNOTES

1.   The Debtor's former member, Diamond Law P.C. and its principal, Scott F. Diamond, were parties to the 2017 loan executed with Virage. Doc. # 124.

2.   The Virage claim includes interest calculated at a rate of 22.5% and a default interest rate calculated at 27.5%, which results in a total of $8,253,883.87 in interest on unpaid principal of $5,773,767.92. Doc. # 124, Ex. 5; Tr. at 28, 55-57; Proof of Claim # 10-1.

3.   Virage was joined in its motion by Jordan. Doc. # 129.

4.   Because dismissal is warranted under § 1112, I need not rule as to whether Virage is entitled to relief from the automatic stay. Additionally, because neither party contends it's in the best interest of the creditors and estate to convert the Debtor's case to a Chapter 7, and because a Chapter 7 liquidation would leave all creditors with little to no value, I need not rule on the issue.

5.   Virage notes the Debtor also receives rental payments from its sublessee in the amount of $15,250.00 per quarter. However, on April 12, 2024, the Debtor stipulated with its landlord to reject its lease. Doc. # 139.

6.   This valuation excludes the maximum recoverable fees on the Debtor's pre-petition contingent fee cases. The Debtor's maximum recovery on such cases is 3,600,000.00. Defendant's Ex. 6. However, such a recovery remains speculative.

PATRICIA M. MAYER U.S. BANKRUPTCY JUDGE