The opinion of the court was delivered by: Brieant, J.
Appellant Derivium Capital, LLC ("Derivium" or "Debtor") appeals from a November 4, 2005 Order of United States Bankruptcy Judge Cecelia G. Morris, which converted the Debtor's Chapter 11 bankruptcy proceeding into a Chapter 7 case. On March 13, 2006, four loan borrowers from Derivium ("Borrowers") filed a motion (Doc. 25) seeking leave to join Debtor's appeal or to file an amicus brief. Counsel for all parties appeared before the Court for oral argument on March 22, 2006.
The following information appears of record and is not disputed, except as noted below. Derivium began business in 1997 under the name of First Security Capital, LLC, and offered a financial product claimed to be proprietary, which it called a "90% Stock Loan," by which transaction a borrower would pledge certain eligible publicly traded stock to secure a non-recourse loan in the amount of 90% of the market value of the stock. The loan would typically mature after three years with interest accruing at 10% to 12% per annum. At maturity, the borrower had the choice either to pay the amount due on the loan with interest and the Debtor would return the stock pledged, or, if the value of the stock was less than the loan principal plus interest, the borrower could walk away from the transaction without any further obligation. A borrower could also sometimes extend the loan period by agreement. Derivium apparently did not itself fund the loans, but merely sold the product and arranged for funding originally by an Irish corporation named Diversified Design Associates, and subsequently by Bancroft Ventures, Ltd. ("Bancroft"), an Isle of Man corporation located in Cyprus.
The lure by which the product was sold, was as a tax shelter. By entering into the transaction, as opposed to merely selling his stock at 100% of market value, the borrower could convert short term capital gain to long term gain, and postpone the recognition of the tax until the end of the loan period. Derivium approved each stock transaction, rejecting those involving thinly traded or highly volatile issues. Few blue-chip stocks appreciate more than thirty percent in value over a three year period. Even if a particular issue did so, the borrower, upon redeeming, would get the stock back at his original basis. Accordingly, there was little expectation that any borrower would ever redeem his stock at the end of the loan period.
From the period of 1998-2002, Derivium marketed approximately 1,700 loan transactions, in total worth approximately $1 Billion, and generated commissions (the 10% up-front discount) to Derivium of approximately $22 Million. The stock was sold in most cases shortly after receipt by the Debtor or the Debtor's off-shore lender, without consulting the Borrowers, and Debtor asserts that in doing so it acted under the direction of its then-lender, Bancroft. The Debtor entered into hedging transactions, mostly in real estate investments, relying on profits for the ability ultimately to return the stock to those clients at the end of the loan term, who might seek to repay the loan. Administrative overhead and sales commissions exceeded the immediate 10% economic benefit flowing to the Debtor when the transaction was booked. Debtor, in order to earn enough to remain solvent, claims it had a proprietary hedging program for investing which its lender controlled.
As might be expected, and as discussed infra,the Internal Revenue Service ("IRS") commenced an investigation into the Debtor's business in 2004, and in letters sent by the IRS to borrowers under the program, it indicated that it believed, among other things, that the borrowers' stock pledged to Derivium was sold before the borrowers received their funds, and that the proceeds were actually the source of the funds Derivium then loaned to the borrowers. The IRS has taken the litigation position that the sales were closed transactions for tax purposes in the year the loan was made.
Debtor ceased doing business toward the end of 2001 because of litigation brought by the State of California's Corporations Commissioner ("California") against Debtor and related defendants. California sought to enjoin Derivium from marketing the 90% Stock Loan, claiming inter alia 1) that the transactions were sales of securities and thus required a broker/dealer license under California Corporations Code §250210 (a); and 2) that the Debtor acted as an unlicensed finance lender or broker in making consumer or commercial loans in violation of California Finance Lenders Law.
On November 5, 2003, the Superior Court of California, County of Sacramento, granted summary judgment to Derivium on the issue of whether the transactions constituted sales rather than loans pursuant to the Corporations Code, and concluded that Derivium's 90% Stock Loans were bone fide loans. It denied summary judgment to Derivium on the question of whether Derivium acted as a broker without a license for a finance lender making consumer or commercial loans, in violation of the Financial Code. See App. 109 -114. The Superior Court of California noted that while "the immediate liquidation of the security may have many untoward impacts upon the parties to the transaction, those potential impacts have no apparent relevance to the bone fide nature of the primary transaction." App. 110. The Superior Court found that the "Commissioner has presented no authorities to support the proposition that a pledgee of [fungible] stock as security, or its agent, cannot liquidate the pledged securities absent a default, or that the fact of such liquidation affects the bona fide nature of the secured transaction" and that "[i]n the end, [Derivium's] initial contention that the transaction were loans was the only position supported by evidence in the record." App. 110, 112. Obviously, these legal conclusions are not binding on the IRS.
Debtor asserts that notwithstanding the Superior Court's finding that the transactions were true loans, the pendency of the litigation had a devastating effect on Derivium's business, including necessitating the total cessation of business activities in California since late 2001, and the termination of its relationship with its source lender, Bancroft, which was named as a party to the California action. In December 2002, Derivium and Bancroft executed a termination and settlement agreement in which Bancroft agreed to indemnify Derivium for claims asserted by any borrowers under the 90% Stock Loan program.
In 2003, Derivium became the subject of lawsuits in various states instituted by a number of borrowers seeking to redeem their stock upon loan maturity. Upon election by the borrowers to receive back the number of shares pledged, Derivium could not perform, Bancroft did not perform and the borrowers instituted suit. Debtor asserts that due to Bancroft's failure to honor its indemnification agreement, Debtor has been found liable in several arbitration awards totaling approximately $75 million.
In December 2004, the IRS issued information document requests followed by summonses, seeking information about the Stock Loan program as part of a Section 6700 investigation. The IRS notified certain known borrowers, including the Borrowers seeking to intervene in this appeal, of their possible liability for capital gains taxes and penalties, should a determination be made that the transactions were sales of securities at the date made rather than bone fide loans. On October 15, 2005, the IRS commenced an action in the United States District Court for the Southern District of New York against Charles Cathcart, Ph.D., Managing Director of Derivium, seeking to enforce the summonses. In its court filings, the IRS disclosed that the Section 6700 investigation could result in the assessment of civil penalties against the Debtor, tax liabilities to the Borrowers, and a requested injunction from marketing the 90% Loan. On September 1, 2005, Derivium filed a voluntary petition under Chapter 11 of the United States Bankruptcy Court for the Southern District of New York. Debtor claims that the actions in California and by the IRS, as well as the loss of Bancroft as its sole lending source, forced it to shut down its business and precipitated its filing for relief under Chapter 11 of the Bankruptcy Code. Derivium claims it was forced to cease operations until it could obtain a final determination as to the legitimacy of the 90% Stock Loan program and thereafter secure a new lending partner, while obtaining a reprieve from the customer litigation. The Debtor's stated intention as a Chapter 11 Debtor was the filing of a motion pursuant to 11 U.S.C. §505, to obtain a determination that the transactions were actually bone fide loans and not securities sales, which determination would enable the Debtor to resume its operations, but this was never done.
On September 21, 2005, five (5) days after the September 16, 2005 date by which Derivium's Schedules and Statement of Financial Affairs were due to be filed under 11 U.S.C. §521 and the Federal Rules of Bankruptcy Procedure 1007(b), the United States Trustee for the Southern District of New York ("US Trustee") filed a motion to convert the Chapter 11 case to a Chapter 7 case, or to dismiss the Chapter 11 case ("Motion to Convert"), claiming that the delayed filing "demonstrate[d] bad faith and an unreasonable delay that is prejudicial to creditors, which constitutes cause to convert or dismiss this case pursuant to 11 U.S.C. §1112(b)" and that the "failure to file schedules of assets and liabilities and statements of financial affairs and executory contracts independently constitutes cause to convert or dismiss the case pursuant to 11 U.S.C. §1112(e)." App. 19. On October 27, 2005, the U.S. Trustee filed a Supplemental Memorandum of Law and Statement in Further Support of the Motion to Convert.
On November 3, 2005, the Bankruptcy Judge held a hearing by way of telephonic conference call on the Motion to Convert. On November 4, 2005, Judge Morris entered an order for conversion ("Conversion Order") of Debtor's Chapter 11 case to a Chapter 7 case, finding that cause existed for the relief requested, and specifically relying on all the following factors: 1) Debtor's lack of insurance; 2) Debtor's lack of profit during its pre-petition period of operation; 3) Debtor's inability to effectuate a plan; 4) Debtor's failure to timely file [a] monthly financial statement, which when filed was not signed, verified, or prepared in compliance with the U.S. Trustee's Operating Guidelines; 5) Debtor's failure to provide the United States Trustee with a requested sworn statement regarding the amounts paid to the Debtor's principals (Debtor furnished only an attorney's letter); 6) The representation of the Debtor-in-possession by professionals retained without approval by the Court, in contravention of the bankruptcy laws; 7) Debtors's improper inclusion of an insider in the list of the twenty largest creditors filed with the Court; 8) A pattern of delay, including the untimely filing of schedules and the list of creditors, and the Debtor's principal being out of the country on the date of the Section 341(a) meeting; 9) The debtor's pattern of making determinations without required Court involvement, including the untimely filing of schedules without seeking an extension of time; the Debtor's principal making the decision to not appear at the initial Section 341(a) meeting without seeking leave of Court; and the representation of the estate [in South Carolina] by professionals not retained by Court order; 10) Debtor's failure to pay required quarterly fee pursuant to 28 U.S.C. §1930(a)(6); and 11) Debtor's failure to adequately account for the $20 to $25 million in commissions allegedly earned during its pre-petition operations. The Bankruptcy Court also concluded that the arguments of the Debtor-in-possession were not compelling because it has failed to file any documents with the Court to retain tax counsel, to seek a determination of tax liability under 11 U.S.C. §505 or to seek approval of its purported financing during the pendency of the Chapter 11 case. See App. 153-155.
On the same day, November 4, 2005, the Bankruptcy Court also entered an order transferring venue to the District of South Carolina upon the motion of Mr. Richard Sabelhaus, the Chairman of the Creditors Committee. The transfer order is not apparently challenged although as discussed infra, the U.S. Trustee challenges this Court's current jurisdiction over this appeal, following the Bankruptcy Court's transfer of the case to South Carolina.
On November 7, 2005, Kevin Campbell was appointed as the Chapter 7 Trustee by the Bankruptcy Court for the District of South Carolina. According to Mr. Sabelhaus' counsel, two out of three members of the Creditors Committee supported the conversion to a Chapter 7 proceeding. The Chapter 7 Trustee, Mr. Kevin Campbell, requests that the Court dismiss the appeal or affirm the order converting the Debtor's case into a Chapter 7 case.
Appellants moved timely for reconsideration of the Conversion Order under Rule 60(b) of the Federal Rules of Civil Procedure ("FRCP") for "mistake, inadvertence, surprise or excusable neglect" or "any other reason justifying relief." A telephonic conference call on the motion was conducted on November 29, 2005. On December 1, 2005, Judge Morris entered an order denying the motion for reconsideration, finding that the Debtor did not make the requisite showing that the Court either based its decision on a misapprehension or mistake of fact, that it overlooked material facts, or that the Debtor's failures properly to comply with the requests of the U.S. Trustee, certain provisions of the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure, constituted excusable neglect.
Debtor appeals the Conversion Order and the denial of Reconsideration, arguing that the Bankruptcy Court erred in the following ways: 1) by finding that Derivium engaged in a pattern of delay; 2) by finding that Derivium is unable to effectuate a plan of reorganization; 3) by finding that Derivium failed to earn a pre-petition profit; 4) by finding that Derivium failed to adequately account for the $20 to $25 million in commissions earned by the Debtor during its pre-petition operations; 5) by finding that Derivium failed to pay the quarterly fee pursuant to 28 U.S.C. §1930(a)(6); 6) by finding that Derivium failed to provide a sworn statement concerning amounts paid to Derivium's principals pre-petition; 7) by finding that Derivium failed to file documents with the Court to seek a determination of tax liability; 8) by ...