UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF ALASKA

Sea Hawk Seafoods, Inc. (Sea Hawk) has moved for dismissal of Valdez Fisheries Development Association's (VFDA) Chapter 11 petition or alternatively, for appointment of a Chapter 11 trustee. Sea Hawk has also moved to shorten the time for plan exclusivity. This is a core proceeding under 28 U.S.C. § 157(b)(2)(A) & (O). Jurisdiction arises pursuant to 28 U.S.C. § 1334 (c) and the district court's order of reference. I find that the debtor's Chapter 11 petition was not filed in bad faith and dismissal is not warranted. I further find that appointment of a trustee and shortening the time for plan exclusivity is unnecessary. Sea Hawk's motions will be denied in a separate order.

Background

Sea Hawk operates a seafood processing plant in Valdez. It is a for profit corporation owned by Terry Bertoson of Seattle. Sea Hawk recently emerged from Chapter 11 proceedings in the Western District of Washington.

VFDA is a non-profit corporation operating a fish hatchery in Valdez. It has developed a valuable pink salmon run in Prince William Sound. VFDA opened in 1981 and has been capitalized through a series of loans from the State of Alaska 5 ABR 407      (State). Those loans totaled nearly $8 million as of March of 1998. The State has a perfected security interest in all VFDA assets.

VFDA's Chapter 11 proceeding arises out of a purchase agreement with Sea Hawk for its Valdez plant. In 1993 Alyeska Pipeline Service Company (Alyeska) was interested in leasing Sea Hawk's plant for use as a wildlife rehabilitation center. Alyeska negotiated with Sea Hawk regarding the possible sale of the facility to VFDA with a leaseback to Alyeska. VFDA and Alyeska executed a $2.5 million purchase agreement contingent on Alyeska's approval of a proposed lease. Alyeska did not approve a lease and the sale did not close. Despite Alyeska's failure to approve a lease, Sea Hawk sued VFDA for breach of contract, misrepresentation and promissory estoppel. VFDA brought a third party action against Alyeska. The state superior court dismissed VFDA's complaint and awarded Alyeska over $53,000.00 in attorney's fees and costs. The jury rendered a verdict for Sea Hawk in the sum of $1,535,974.00 based upon its claim for promissory estoppel on July 18, 1997. Damages were based upon Sea Hawk's failure to operate during the summer of 1994. VFDA has appealed the decision. The superior court also awarded attorney's fees to Sea Hawk. Sea Hawk's judgment totaled over $2.1 million as of March 23, 1998.

VFDA made numerous attempts to avoid execution during the appeal. It filed motions seeking a stay pending appeal in superior court. These motions were denied on August 26, 1997. VFDA requested a stay from the Supreme Court. Their request was remanded to the superior court. The superior court placed limitations on Sea Hawk's ability to execute on assets to preserve VFDA's public interest functions. Any executions were to be reviewed by the court prior to retention by Sea Hawk.

5 ABR 408      On August 27, 1997 the VFDA received a Notice of Default from the State. VFDA turned over approximately $1.7 million in cash to the State. $410,000 in receivables were also assigned to the State. The State then agreed to a new

$1 million operating loan to be disbursed through a trust account at Schmitz and Buck, a Juneau accounting firm. On October 14, 1997 Sea Hawk filed a fraudulent conveyance action against VFDA and the State based upon the return of $2.1 million in cash and receivables after the State's notice of default. That action has been stayed by the current Chapter 11 proceeding.

Sea Hawk obtained writs of execution against VFDA in October of 1997. Sea Hawk levied upon the Schmitz and Buck account at National Bank of Alaska. It received $20,372.42 from the trust account. The superior court issued a March 9, 1998 order allowing Sea Hawk to retain the funds. It further provided that "Sea Hawk is free to execute on cash, on the buildings, and the real estate and on the roe, for that matter . . . bankruptcy or piecemeal disassembly of VFDA is inevitable." VFDA made one more attempt to stay execution with the Supreme Court. Its petition was denied. VFDA filed for Chapter 11 relief on March 23, 1998.

Bad Faith

Sea Hawk seeks dismissal of VFDA's Chapter 11 petition on the grounds of bad faith. Section 1112(b) of the Code allows a court to dismiss a bankruptcy for cause. Although there is no express requirement of good faith in filing a petition, lack of good faith is grounds for dismissal. Marsch v. Marsch (In re Marsch), 36 F.3d 825, 828 (9th Cir. 1994). Courts consider a variety of factors in determining good faith. They include whether:

5 ABR 409     
(1) the debtor has only one asset;

(2) the debtor has an ongoing business to reorganize;

(3) there are any unsecured creditors;

(4) the debtor has any cash flow or sources of income to sustain a plan of reorganization or to make adequate protection payments; and

(5) the case is essentially a two party dispute capable of prompt adjudication in state court.

In re St. Paul Self Storage Ltd. Partnership, 185 B.R. 580 (9th Cir. B.A.P. 1995).

The debtor meets the general requirements for a good faith filing. The debtor has a variety of assets. It leases real property consisting of the hatchery site. It owns personal property, primarily the personal property making up the hatchery plant, valued at over $4 million as a going concern. The debtor has employees and an ongoing business. The business is about to harvest 50% of the Prince William Sound pink salmon run to cover its annual expenses of operation. This income constitutes cash flow that could be used to sustain a plan of reorganization or to make adequate protection payments. There are unsecured creditors. The State's claim may be unsecured by as much as $6 million. This amount could increase another $2.1 million if Sea Hawk or the debtor were to recover on an avoidance action. Sea Hawk has an unsecured claim of over $2.1 million. Alyeska is owed over $50,000.00 and there are several small trade accounts.

This case is not essentially a two party dispute that has been brought to this court for adjudication. The state law dispute among VFDA, Alyeska and Sea Hawk is a three party dispute which will be decided by the Alaska Supreme Court, not 5 ABR 410      by this court. Relief from stay has been given for pursuit of appeals and resolution of all issues on appeal. The reorganizational issues necessarily involve those parties and the State.

Sea Hawk argues that the debtor is using the current Chapter 11 proceeding in bad faith as a substitute for a supersedeas bond. As I noted in Nome Commercial Company, 4 A.B.R. 358, 363-364 (Bankr. D. Alaska 1996):

Two lines of case law have emerged on the issue of bad faith use of a chapter 11 petition as an alternative to posting a supersedeas bond. Higashi prefers a line of cases dismissing Chapter 11 cases on bad faith grounds under such circumstances. In re Wally Findlay Galleries (New York), Inc., 36 B.R. 849 (Bankr. S.D.N.Y. 1984); In re Smith, 58 B.R. 448 (Bankr. W.D. Ky. 1986); In re Karum Group, Inc., 66 B.R. 436 (Bankr. W.D. Wash. 1986); In re Business Information Co., Inc., 81 B.R. 382 (Bankr. W.D. Pa. 1988); In re Nahas, 95 B.R. 387 (Bankr. W.D. Pa. 1989). A number of other courts have not dismissed chapter 11 petitions utilized as alternatives to a supersedeas bond. In re Alton Telegraph Printing Co., 14 B.R. 238 (Bankr. S.D. Ill. 1981); In re McLaury, 25 B.R. 30 (Bankr. N.N. Texas 1982); In re Corey, 46 B.R. 31 (Bankr. D. Hawaii 1984); In re N.R. Guaranteed Retirement, Inc., 112 B.R. 263 (Bankr. N.D. Ill. 1990), aff'd, 119 B.R. 149 (N.D. Ill. 1990); In re Askinuk Corporation, 3 A.B.R. 251 (Bankr. D. Alaska 1993). These two lines of cases can generally be reconciled. In re Holm, 75 B.R. 86, 87 (Bankr. N.D. Cal. 1987). In the cases denying dismissal motions, the judgment was large and if not reversed on appeal, would force the liquidation of the business. In those cases dismissing the petition, with the exception of Karum Group and Nahas, the judgments were smaller, and the debtor had the apparent ability to satisfy the judgments and stay in business. Karum Group dismissed a petition when dismissal would result in the liquidation of the debtor's business due to the inability of the debtor to satisfy the judgment. In Nahas, there was no business to protect as the debtors were simply wage earners.

The same rationale applies here. VFDA has pursued every possible option in lieu of bankruptcy. It has attempted to obtain a waiver of the bond requirements and limitations on execution in state court on many occasions without success. It could not pay off the judgment or fund a bond out of non-business assets because it has no non-business assets. The State refused to subordinate its security interest for bonding purposes. Continued execution by Sea Hawk could severely disrupt the debtor's business if not end it altogether. Based on the superior court's March 9, 1998 order, Sea Hawk was apparently free to execute upon any of the debtor's assets and ignore the State's perfected security interest in those assets. Filing for Chapter 11 relief was appropriate under those circumstances.

Sea Hawk alleges that VFDA's transfer of $2.1 million in cash and receivables to the State constituted a fraudulent transfer and a preference making their Chapter 11 filing in bad faith. I disagree for several reasons. First, the transfer was to a creditor with a perfected security interest in all assets of the debtor. It was not made to a friend or relative of the debtor for no consideration as found in many fraudulent transfer cases. Second, the debtor is a creature of the State. It is strictly regulated and must go through a series of bureaucratic approvals on its annual budget. Loans to the debtor are far below market and the State subsidizes and controls the debtor's financial status. Given the size of Sea Hawk's judgment, the debtor was simply in no position to battle its primary lender over repayment of debt. Moreover, following the transfer, the debtor has received over $1 million in new loans with an 5 ABR 412      additional $350,000.00 currently before the court. Finally, even if the transfer had not been made, VFDA was in no position to post a bond or pay the judgment without going out of business. Assuming that $1.1 million of the transfer was a "reserve" or not needed for operations, it falls far short of the cash required to post a bond or satisfy the judgment.

Sea Hawk argues that VFDA has the ability, through increasing its share of the pink salmon harvest, to pay Sea Hawk or post a bond and that VFDA's failure to do so constitutes bad faith. This argument has a superficial appeal. It is true that the debtor can increase its share of the harvest to cover operational expenses. It has already increased its share of the 1998 catch from 40% to 50%. If prices are high enough and the salmon plentiful enough, an additional recovery of $1.5 to $2 million is possible. Sea Hawk neglects to mention the commercial, sport and subsistence fishermen who would be injured through such precipitous action, however. VFDA's share of the harvest is established through reaching consensus with its constituent fishermen. By taking all of the catch, VFDA would alienate its constituency and subject itself to substantial post-petition liability to the fishermen it was meant to serve. Taking 100% of the catch would also violate State regulations governing the amount of harvest recoverable by a hatchery. VFDA's refusal to take 100% of the harvest is justified and does not manifest bad faith on its part.

VFDA meets the criteria for a good faith filing. It has multiple assets and an ongoing business. It has several major unsecured creditors. It has cash flow and sources of income to sustain a plan or reorganization. This case is more than a two party dispute and the petition was necessary to avoid destroying its business. VFDA's 5 ABR 413      pre-petition transfer to the State and its refusal to immediately take 100% of the 1998 fish harvest do not make its filing in bad faith.

Appointment of a Trustee

Sea Hawk has moved for appointment of a trustee under 11 U.S.C. § 1104(a)(1) for cause. Section 1104(a)(1) allows the appointment of a trustee for fraud, dishonesty, incompetence or gross mismanagement of the affairs of the debtor. The burden of proof rests on Sea Hawk. It must prove cause for appointment of a trustee by clear and convincing evidence. In re Colorado-Ute Elec. Association, Inc., 120 B.R. 164 (Bankr. D. Colo. 1990); Matter of PMH Corp., 116 B.R. 644 (Bankr. N.D. Ind. 1989). Appointment of a trustee in Chapter 11 is an extraordinary remedy and there is a strong presumption that the debtor should remain in possession. In re Heck's Properties, Inc., 151 B.R. 739 (Bankr. S.D.W.Va. 1992).

The management of the debtor consists of a board of directors drawn from the Valdez community. David Cobb has served as business manager for VFDA for over 5 years. Cobb has worked for VFDA since 1982. He also serves as mayor of Valdez. Other members of the board have long experience with VFDA along with extensive experience in government, local businesses and fishing. VFDA's management has successfully created a large pink salmon run in Prince William Sound. Through its development of pink and chinook salmon runs, it was able to regularly meet its financial obligations to the State and comply with the myriad of regulations imposed upon hatcheries. The State views it as a successful hatchery that has dramatically improved the Prince William Sound fishing industry.

Sea Hawk argues that the VFDA board of directors and business manager 5 ABR 414      have repeatedly demonstrated incompetence and gross mismanagement in VFDA's business affairs by litigating Sea Hawk's claim and refusing to engage in meaningful settlement discussions over the last four years. The board's handling of one lawsuit is not clear and convincing evidence of incompetence or gross mismanagement justifying appointment of a trustee. Many of the nation's best run companies regularly face lawsuits and sometimes lose them, resulting in large judgments. Seldom do these companies immediately replace otherwise competent and successful management because of the results of one lawsuit. Moreover, Sea Hawk and Alyeska still have to face the Alaska Supreme Court. VFDA's position may yet be vindicated. Sea Hawk alleges that VFDA lost $500,000.00 through investment in the stock of Health Sea, Inc. for production of "salmon hams". Health Sea went bankrupt and VFDA lost its investment. Without more evidence, this simply indicates that VFDA made a poor investment. It is not clear and convincing 5 ABR 415      evidence of gross mismanagement of the debtor's overall affairs.

Sea Hawk alleges fraud and gross mismanagement through VFDA's payment of $2.1 million in cash and receivables to the State following Sea Hawk's verdict. As noted previously, the State is VFDA's largest creditor. It has a perfected security interest in all of its assets. Sea Hawk is simply an unsecured creditor with no rights in the State's collateral. The State apparently feared that its security interest would be ignored and that Sea Hawk would be allowed to execute against its cash collateral and disrupt VFDA's operations. Given the rulings of the state superior court and its award of $20,000.00 of the State's collateral to Sea Hawk, those fears were well justified. Under these circumstances, VFDA's transfer is not clear and convincing evidence of gross mismanagement. Rather, it was simply an effort to preserve VFDA's secured business assets from disruptive nuisance executions. It does not constitute clear and convincing evidence of fraud or gross mismanagement.

Finally, Sea Hawk contends a trustee must be appointed to pursue fraudulent transfer and preference claims against the State⁽¹⁾. I disagree for a number of reasons. First, I have reservations as to the viability of such claims against a party that held and continues to hold a perfected security interest in all of the debtor's assets while continuing to advance substantial funds (approx. $1.35 million) for the debtor's benefit. Second, even if the claims had viability, Sea Hawk's maximum share of the proceeds would be 21% to 26% (assuming the debtor had no priority or administrative claims). After recovery of any alleged preferences or fraudulent conveyances the State's unsecured claim would increase by the amount of the recovery. The State's unsecured claim of $6.1 to $8.1 million would dwarf Sea Hawk's claim. Finally, if the debtor can propose a confirmable plan, pursuit of the litigation at this time is a pointless distraction. If the debtor cannot propose a confirmable plan, the case will be promptly dismissed or converted. Sea Hawk or a Chapter 7 trustee, if appropriate, can pursue the claims at that time. There is no need to pursue litigation in three separate forums when presentation of a viable plan of reorganization could render the estate's avoidance claims moot.

5 ABR 416      Given the qualifications of the current board, and the fact that the debtor's largest creditor opposes the current motion, I find that appointment of a trustee is not in the interests of creditors and other interests of the estate under 11 U.S.C. § 1104(2).

Plan Exclusivity

Sea Hawk seeks to shorten the time for plan exclusivity under 11 U.S.C. § 1121(d). In reviewing the factors set forth in In re Express One International, Inc., 194 B.R. 98, 100 (Bankr. E.D. Tex. 1996), I conclude there is no tangible advantage available to creditors or the estate by shortening the 120 day exclusivity period. The motion will be denied.

Conclusion

VFDA's Chapter 11 filing represents a good faith filing by a beleaguered debtor in danger of losing its fundamental business assets. The debtor's management has not been grossly incompetent or fraudulent and there are no grounds for the appointment of a trustee or shortening the time for plan exclusivity. Sea Hawk's motions have no merit.

DATED: June 8, 1998.

DONALD MacDONALD IV
United States Bankruptcy Judge

1. ¹ 5 ABR 415      Sea Hawk implies that this court erred by denying its motion for relief from stay without addressing the "merits" of the claim. Counsel's belated acknowledgment that any recovery would have to benefit the estate did not cure the core defect presented by Sea Hawk's motion for relief from stay. Nothing contained in the motion or notice for relief from stay in any way addressed standing or moved for authority to pursue the actions on behalf of the estate. As filed, the motion sought relief from stay for Sea Hawk to continue the litigation and collect its judgment. Counsel's later acknowledgment cannot cure such a fundamental defect.