Court Opinion

ID: 9905589
Source: CourtListenerOpinion
Date Created: 2023-11-29 20:00:41.462566+00
Date Added: 2024-06-11T09:23:45.818045
License: Public Domain

RECOMMENDED FOR PUBLICATION
                               Pursuant to Sixth Circuit I.O.P. 32.1(b)
                                      File Name: 23a0259p.06

                   UNITED STATES COURT OF APPEALS
                                 FOR THE SIXTH CIRCUIT

                                                            ┐
 IN RE: CALIFORNIA PALMS ADDICTION RECOVERY
                                                            │
 CAMPUS, INC.,
                                                            │
                                       Debtor.              │
  ___________________________________________                >        No. 23-3375
                                                            │
 CALIFORNIA PALMS ADDICTION RECOVERY CAMPUS,                │
 INC.; SEBASTIAN RUCCI,                                     │
                                   Appellants,              │
                                                            │
        v.                                                  │
                                                            │
                                                            │
 ANDREW R. VARA, United States Trustee,                     │
                                              Appellee.     │
                                                            ┘

 Appeal from the United States District Court for the Northern District of Ohio at Youngstown;
                   No. 4:22-cv-00812—Benita Y. Pearson, District Judge.
       United States Bankruptcy Court for the Northern District of Ohio at Youngstown;
                  No. 4:22-bk-40065—John P. Gustafson, Bankruptcy Judge.

                           Decided and Filed: November 29, 2023

              Before: WHITE, THAPAR, and BLOOMEKATZ, Circuit Judges.

                                     _________________

                                           COUNSEL

ON BRIEF: Sebastian Rucci, LAW OFFICE OF SEBASTIAN RUCCI, P.C., Huntington
Beach, California, for Appellants. Frederick Gaston Hall, UNITED STATES DEPARTMENT
OF JUSTICE, Washington, D.C., Lauren C. Schoenewald, UNITED STATES DEPARTMENT
OF JUSTICE, Cleveland, Ohio, for Appellee.
 No. 23-3375               In re Cal. Palms Addiction Recovery Campus, Inc.                          Page 2

                                           _________________

                                                OPINION
                                           _________________

        THAPAR, Circuit Judge. California Palms Addiction Recovery Campus was established
to help people get a fresh start. When it filed for bankruptcy, California Palms hoped for a fresh
start of its own. But the bankruptcy court determined that California Palms couldn’t financially
rehabilitate, so it converted the proceedings from chapter 11 bankruptcy to chapter 7. We affirm.

                                                      I.

        California Palms Addiction Recovery Campus operated a substance abuse treatment
center in Ohio. But California Palms and its sole owner Sebastian Rucci ran into legal and
financial troubles. Ohio revoked California Palms’s operating license. The U.S. Department of
Justice (DOJ) seized nearly $600,000 from California Palms for alleged fraud. And California
Palms had an ongoing legal battle with a creditor, Pender, over its building lease.

        On the brink of eviction, California Palms sued Ohio to recover its license, and California
Palms and Rucci sued the DOJ to recover the seized assets. California Palms also filed for
chapter 11, subchapter V bankruptcy. This would allow California Palms to try to turn the
business around, but only if it could do so within an accelerated timeline.                   See generally
11 U.S.C. §§ 1187–95.1 Its plan for reorganization depended almost entirely on the success of
its pending lawsuits—but success was far from certain. Concerned that the litigation would
bleed the estate dry, the Trustee supervising the case urged the bankruptcy court to convert the
matter to a proceeding under chapter 7 for liquidation.

        The court put the Trustee’s motion on hold to await developments in California Palms’s
other lawsuits. But the court cautioned California Palms that it would take “very, very little” to
convert to chapter 7 bankruptcy. R. 125-1, Pg. ID 30. Two weeks passed, but instead of good
news, the lawsuit over the seized assets was put on hold while the DOJ pursued a criminal

        1Although a small-business debtor generally has one hundred eighty days to file a reorganization when
proceeding under chapter 11, 11 U.S.C. § 1121(e)(1), that timeline is shortened to ninety days when proceeding
under subchapter V, id. § 1189(b).
 No. 23-3375                  In re Cal. Palms Addiction Recovery Campus, Inc.                                Page 3

indictment. California Palms also failed to meet the deadline the bankruptcy court set to provide
an accounting of post-petition bank transactions to the Trustee. So the court scheduled a show-
cause hearing, requiring California Palms to explain why the chapter 11 case should not be
converted to a Chapter 7 proceeding.

         Two days before the hearing, California Palms’s attorney James Vitullo moved to
withdraw as counsel. (Vitullo withdrew because his prior relationship with Rucci and California
Palms created a conflict of interest.) See 11 U.S.C. §§ 327(a), 1107; Fed. R. Bankr. P. 2014.
Less than an hour before the hearing, Rucci—who is also a lawyer—filed an objection to the
Trustee’s motion to convert. At the hearing, the court asked Rucci if he objected to Vitullo’s
withdrawal. Rucci did not, nor did he request a continuance to get a new attorney. The
bankruptcy court granted Vitullo’s motion. Then, after making factual and legal findings, the
bankruptcy court converted the proceedings to chapter 7.

         It has continued to be a rocky road for California Palms. Pender successfully evicted
California Palms from the property where it operated its center. An Ohio court upheld the
revocation of its license. A Sixth Circuit panel denied California Palms’s petition for a writ of
mandamus to return the seized $600,000. And the district court affirmed the conversion order.
California Palms and Rucci now appeal the conversion order.2

                                                          II.

         Before reaching the merits, we first resolve one jurisdictional issue: finality.

         Ordinarily, only “final decisions, judgments, orders, and decrees” are appealable.
28 U.S.C. § 158(d)(1). A decision is typically considered final if it leaves nothing for a court to
do but execute the judgment. In re Jackson Masonry, LLC, 906 F.3d 494, 498 (6th Cir. 2018).
But bankruptcy is different.           See Bullard v. Blue Hills Bank, 575 U.S. 496, 501 (2015).
Bankruptcy often involves many distinct disputes involving a variety of rights and interests, so

         2As the parties properly agree, California Palms has standing because losing its ability to operate is an
adverse, pecuniary consequence directly resulting from conversion. Fidelity Bank v. M.M. Grp., Inc., 77 F.3d 880,
882 (6th Cir. 1996). We therefore do not need to address Rucci’s standing “because the presence of one party with
standing is sufficient to satisfy Article III’s case-or-controversy requirement.” Rumsfeld v. F. for Acad. & Inst. Rts.,
Inc., 547 U.S. 47, 52 n.2 (2006).
 No. 23-3375                 In re Cal. Palms Addiction Recovery Campus, Inc.                           Page 4

courts take a broader view of finality. Jackson Masonry, 906 F.3d at 498. A final order in
bankruptcy cases is one (1) entered in a “proceeding” and (2) “terminating” that proceeding. Id.
at 499.

          Conversion from chapter 11 to chapter 7 meets both requirements.

          First, conversion motions are resolved in proceedings. A “proceeding” is a “discrete
dispute” with specific procedural steps. Id. at 500. Chapter 7 conversion generally begins with a
party’s motion. 11 U.S.C. § 1112(b)(1); Fed. R. Bankr. P. 9014(a). The court holds a hearing on
that motion. 11 U.S.C. § 1112(b)(1). And the court must determine whether there’s statutorily
defined cause to convert. Id. § 1112(b)(4). These are hallmarks of a proceeding. Jackson
Masonry, 906 F.3d at 500.

          Second, granting a motion to convert also terminates the proceeding. Proceedings are
“terminate[d]” when the “status quo” is “alter[ed]” and the “rights and obligations of the parties”
are “fixe[d].” Bullard, 575 U.S. at 502. Here, orders to convert eliminate all rights and
obligations stemming from chapter 11 proceedings. Such orders also bear “significant and
irreparable” consequences, which is indicative of finality. Jackson Masonry, 906 F.3d at 502.
Namely, the debtor loses control of the estate and the opportunity to reorganize.

          Thus, an order granting a motion to convert from chapter 11 to chapter 7 is a final,
appealable order. Our sister circuits who have considered the issue agree.3

                                                        III.

          The bankruptcy court found cause to convert and determined conversion was in the best
interest of the creditors and estate. We review both decisions for abuse of discretion. In re
Mitan, 573 F.3d 237, 247 (6th Cir. 2009).

          3See In re Rosson, 545 F.3d 764, 770 (9th Cir. 2008); In re USA Baby, Inc., 674 F.3d 882, 883 (7th Cir.
2012); In re Fleurantin, 420 F. App’x 194, 196 (3d Cir. 2011) (per curiam).
 No. 23-3375             In re Cal. Palms Addiction Recovery Campus, Inc.                  Page 5

                                                A.

       Converting a case from a chapter 11 reorganization to a chapter 7 liquidation usually
means the underlying business ceases to operate. See Czyzewski v. Jevic Holding Corp., 580
U.S. 451, 455–56 (2017) (comparing proceedings under chapters 7 and 11).              Instead, the
business shuts down, and a trustee distributes its remaining assets to the entity’s creditors. Id.
To convert a chapter 11 case to chapter 7, a court must find cause. 11 U.S.C. § 1112(b)(1). The
Bankruptcy Code provides a list of sufficient causes. Id. § 1112(b)(4). The bankruptcy court
found that four applied: (1) no likelihood of rehabilitation, (2) gross mismanagement, (3) failure
to comply with the Trustee’s request, and (4) failure to comply with a court order. We need only
agree with one of those causes to affirm.

       We begin and end with the first.        Cause exists under this factor when there’s a
“substantial or continuing loss to or diminution of the estate” without “a reasonable likelihood of
rehabilitation.” Id. § 1112(b)(4)(A). The bankruptcy court didn’t abuse its discretion by finding
that California Palms qualified.

       First, California Palms faced substantial and continuing losses.       It wasn’t currently
operating, so it had no income. It had limited assets. And its ongoing litigation continued to
drain those assets. No asset growth plus ongoing costs equals continuing loss. Cf. Loop Corp. v.
U.S. Tr., 379 F.3d 511, 516 (8th Cir. 2004) (holding that any negative cash flow satisfies this
prong if the debtor isn’t operating); 7 Collier on Bankruptcy ¶ 1112.04 (16th ed. 2023). Indeed,
as the bankruptcy court observed, the estate was a “melting ice cube.” Bankr. R. 125-1, Pg. ID
27.

       Second, California Palms wasn’t reasonably likely to rehabilitate. Without a license,
California Palms couldn’t return to business. And a significant portion of its assets had been
seized by the DOJ. So rehabilitation depended on pending litigation. But the DOJ lawsuit had
been put on pause until the DOJ’s fraud investigation into California Palms concluded. Given
the “short deadlines” imposed for subchapter V cases, the bankruptcy court held that Rucci
would not be able to complete his “litigation-based rehabilitation” “in a reasonable amount of
time.” Bankr. R. 125-2, Pg. ID 14, 28.
 No. 23-3375             In re Cal. Palms Addiction Recovery Campus, Inc.                       Page 6

       Taking the substantial and continuing losses and unlikelihood of rehabilitation together,
the court did not abuse its discretion in finding cause to convert.

                                                  B.

       Upon finding cause, a bankruptcy court in a subchapter V case can either (1) convert to
chapter 7 or (2) dismiss the proceeding. 11 U.S.C. §§ 1112(b)(1), 1181(a). The court must
choose the option that’s in the best interests of the creditors and estate. Id. § 1112(b)(1).

       California Palms claims the court failed to consider its interests. But the bankruptcy
court weighed the interests of all parties in deciding whether to dismiss or convert the case. The
court acknowledged that the possibility of California Palms recovering assets from litigation
would decrease under chapter 7. But the court also observed that the litigation was dragging on,
and the estate’s resources were steadily diminishing in the meantime. California Palms’s failure
to meet deadlines and the court’s concerns about mismanagement suggested California Palms
could not be counted on to protect the estate for the creditors. Moreover, California Palms’s
largest creditor, Pender, supported conversion. The court didn’t abuse its discretion by ordering
conversion in these circumstances.

                                                  C.

       California Palms offers three responses. None succeeds.

       First, it argues that the bankruptcy court did not explicitly find that there was a
“continuing loss” to the estate. True, the court didn’t use that specific phrase. But the lack of
“magic words” isn’t an abuse of discretion. “[F]indings are to be liberally construed in support
of a judgment, even if the findings are not as explicit or detailed as might be desired.” In re
Fordu, 201 F.3d 693, 710 (6th Cir. 1999). “[T]he nature of the case” dictates the necessary
“detail and exactness,” and the record must “give an appellate court a clear understanding of the
basis” for the bankruptcy court’s decision. Id. Here, the court found that the estate’s assets
would be “lost” if chapter 11 proceedings continued. Bankr. R. 125-2, Pg. ID 16. That’s
enough.
 No. 23-3375               In re Cal. Palms Addiction Recovery Campus, Inc.                            Page 7

        Second, California Palms argues the bankruptcy court didn’t have enough evidence to
find cause because the motion to convert came too early in the proceeding. But, as we’ve
explained, the bankruptcy court had more than enough evidence before it when it found cause to
convert.

        Third, California Palms contends that the court ignored the purpose of subchapter V. To
be sure, subchapter V can provide greater flexibility and opportunity for small businesses to
reorganize. See generally 11 U.S.C. §§ 1181–95. Even so, the statutory text dictates when
courts should instead convert from subchapter V to chapter 7. Id. § 1112(b); cf. Carcieri v.
Salazar, 555 U.S. 379, 392 (2009). If Congress wanted to allow businesses to stay in chapter 11
when they had no possibility of rehabilitation, it could’ve exempted subchapter V from
conversion—just as it did for other chapter 11 requirements. See 11 U.S.C. § 1181(a). But it
didn’t, so we can’t.

                                                      IV.

        California Palms also argues that the bankruptcy court violated various procedural
requirements. But we reverse a bankruptcy decision on due process grounds only if the error
was prejudicial.       That is, California Palms must show the alleged violations produced a
“substantially different outcome.” Graham v. Mukasey, 519 F.3d 546, 549–50 (6th Cir. 2008).
California Palms has not.

        First, California Palms argues it wasn’t given sufficient notice of the bankruptcy court’s
hearing on April 5, 2023.4 Before a conversion hearing, parties are supposed to get at least seven
days’ notice. Fed. R. Bankr. P. 9006(d). Although the bankruptcy court only gave five, this
procedural flaw didn’t prejudice California Palms. For one, California Palms didn’t object to the
hearing date. Nor did it ask the court for more time to prepare. Moreover, the April 5 hearing
was merely a continuation of a March 15 hearing on the Trustee’s motion to convert. And
California Palms doesn’t even suggest those two extra days would’ve changed the conversion
proceeding’s outcome. For good reason: it had known for forty-six days—from when the

        4California Palms focuses most of its due-process arguments on the failure-to-comply bases for cause. But
because we affirm the bankruptcy court’s cause finding on other grounds, we need not consider those due-process
challenges.
 No. 23-3375             In re Cal. Palms Addiction Recovery Campus, Inc.                   Page 8

Trustee filed the motion to convert—that the bankruptcy court was considering conversion. We
have no reason to believe the difference between forty-six and forty-eight days was anything but
harmless in this case.

       Next, California Palms criticizes the bankruptcy court’s decision to put the conversion
motion on hold. But California Palms doesn’t explain how this violates any rule—procedural or
otherwise. Courts regularly put motions on hold to await results in other litigation. See, e.g.,
Pratt v. Ventas, Inc., 365 F.3d 514, 518 (6th Cir. 2004); In re Martin, 542 B.R. 199, 201 (B.A.P.
6th Cir. 2015). And it made sense for the court to do so here: Rucci suggested to the court that
there’d soon be developments in California Palms’s related litigation. If anything, the court’s
caution benefited California Palms—the court could’ve chosen to convert at the earlier hearing
instead. Thus, this decision was appropriate.

       Finally, California Palms points out it didn’t have an attorney during the second
conversion hearing. See Bass v. Leatherwood, 788 F.3d 228, 230 (6th Cir. 2015). True, the
bankruptcy court dismissed Vitullo before addressing the motion to convert.            But for this
argument to succeed, California Palms must show prejudice. Sours v. General Motors Corp.,
717 F.2d 1511, 1521 (6th Cir. 1980). California Palms fails to even argue that the presence of an
additional attorney would have altered the outcome. As an initial matter, California Palms did
have representation in preparing its defense, as the district court did not grant Vitullo’s motion to
withdraw until the hearing started. And Rucci, who also appeared at the hearing, didn’t object to
the withdrawal, even when specifically asked by the bankruptcy court. Nor did he request a
continuance to get a new attorney. Instead, Rucci, who was an attorney, made arguments that
adequately protected California Palms’s interests.      First, as sole shareholder, Rucci knows
California Palms’s operations and finances better than anyone else. Second, Rucci, who was
already involved as an interested party, had briefed and prepared arguments for the proceeding.
Third, by being present at the hearing, he was able to functionally, even if not technically,
represent California Palms. The bankruptcy court treated him as a suitable representative—and
no party objected to Rucci acting as a stand-in. And on appeal, California Palms proffers no
additional arguments it would have made on the § 1112(b)(4)(A) grounds for conversion, or
steps it would have taken in the bankruptcy court regarding conversion on these grounds, if it
 No. 23-3375            In re Cal. Palms Addiction Recovery Campus, Inc.               Page 9

had had an attorney at the time. To be sure, California Palms lacking an official attorney is a
unique situation that shouldn’t be repeated. But we cannot imagine how, given that the district
court had ample evidence to grant the Trustee’s motion to convert, California Palms suffered
prejudice. Any defect in the conversion hearing was harmless.

                                       *      *       *

       The bankruptcy court did not abuse its discretion in converting California Palms’s
chapter 11 case to chapter 7. We affirm.