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Clear Blue Water, LLC v. Oyster Bay Management Co.

May 24, 2012


The opinion of the court was delivered by: Spatt, District Judge.


The Appellant has commenced the present appeal from a judgment of a bankruptcy court on the basis that the court's dismissal of the Debtor's Chapter 11 bankruptcy petition was clearly erroneous. For the reasons set forth below, the Court finds that the bankruptcy court's determination was not clearly erroneous and thus the Court affirms the dismissal.


On May 10, 2011, the Debtor, Clear Blue Water LLC (the "Debtor" or "CBW"), filed a Chapter 11 Voluntary Petition (the "Petition") for relief under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court for the Eastern District Court of New York (the "Bankruptcy Court"). The Petition was filed by its current managing member, Paul Katsaros, with the intent to reorganize the Debtor. The case was assigned to United States Bankruptcy Judge Robert E. Grossman.

The Debtor manages real property. At the time of the Petition, the Debtor owned three properties: 53-55 Main Street, Cold Spring Harbor, New York (the "Cold Spring Harbor Property"); 263 Sumpter Street, Brooklyn, New York (the "Brooklyn Property"); and 133-43 83rd Street, Ozone Park, New York (the "Queens Property"). However, the previous dismissal and the present appeal largely concern only the Cold Spring Harbor Property.

CBW borrowed $1,087,000 from Washington Mutual Bank in 2008 purportedly to purchase the Cold Spring Harbor Property, which was secured by a mortgage on the property. The Appellee, Oyster Bay Management Co., LLC ("OBM") is the assignee of the note and mortgage secured by CBW's Cold Spring Harbor Property, which was transferred from Washington Mutual Bank, the initial holder of the mortgage. There is no question that the mortgage application made to the bank was in fact fraudulent. (Aug. 1, 2011 Hearing Tr. ("Tr.") at 11:9--16.) In this regard, OBM contends that in the process of obtaining the loan from Washington Mutual Bank, there were several misrepresentations made, including the ownership of and the price paid for the Cold Spring Harbor Property. There is also no dispute that several individuals were indicted for forging documents; presenting fraudulent title reports which omitted ownership of properties and existing mortgages; withholding the filing of deeds and mortgages in order to induce other parties to extend additional credit; and representing that they were owners of property which they did not own. What is presently being disputed is whether the Debtor now must face the consequences of these fraudulent acts.

The Debtor's Counsel indicated at a hearing on August 1, 2011 before the Bankruptcy Court that an individual named Brandon Lisi owned CBW at the time the fraudulent mortgage application was made. (See Tr. at 10:23--11:2.) On July 29, 2011, Lisi pled guilty to three counts of Grand Larceny in Suffolk County Court. As part of his guilty plea, Lisi admitted to stealing U.S. currency from Washington Mutual Bank, the value of which exceeded more than one million dollars, relating to the Cold Spring Harbor Property. (See Appelle Brief, Ex. A.) At the time of the dismissal of the Chapter 11 Petition on August 1, 2011, the Bankruptcy Court did not have the opportunity to view the transcript of Lisi's guilty plea.

This Court was provided with a copy of the transcript and takes judicial notice of the same. See United States v. Alexander, 123 Fed. App'x 444, 446 (2d Cir. 2005) ("Pursuant to Federal Rule of Evidence 201, we may take judicial notice of this [conviction] as it is 'capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned.'" (citing Fed. R. Evid. 201(b)(2)); Schwartz v. Capital Liquidators, Inc., 984 F.2d 53, 54 (2d Cir. 1993) (taking judicial notice of a plaintiff's criminal conviction for making false declarations in his trial testimony); Colonial Penn Ins. Co. v. Coil, 887 F.2d 1236, 1239 (4th Cir. 1989) (holding that it is appropriate to take judicial notice of state court guilty pleas on appeal). Nevertheless, neither party disputed that Lisi had pled guilty to a crime involving the loan obtained from Washington Mutual Bank with respect to the Cold Spring Harbor Property. At the hearing, the following exchange took place:

MR. SIEGEL: Your Honor, just a few things with respect to the innocence of Mr.

Lisi. What he pled guilty to, whether it was mortgage fraud or grand larceny dealt with this specific property. He's clearly pled guilty to being involved in that fraud which --

THE COURT: This property?

MR. SIEGEL: This property.

THE COURT: Why did he plead guilty? He didn't know anything about it?

MR. SIEGEL: I have been asking myself that same question, Judge. And it does baffle me but he did and he pled guilty, I believe three times.

THE COURT: So Mr. Lisi pled guilty to fraud having to do with the particular debtor that I am involved with, with this property.

MR. SIEGEL: But he pled guilty to a crime getting the mortgage or getting the money from the mortgage with this property.

THE COURT: Why did he plead if he didn't know anything about it? Do you know?

MR. LESTER: Judge, I said the same thing. (Tr. at 32:22--33:20.)

At the same hearing in front of the Bankruptcy court on August 1, 2011, Debtor's counsel argued that the original mortgage was entered into not by Lisi, the asserted "owner" of CBW, but by Melissa Lanzilotta. (Id. at 7--8.); (but see id. at 10 ("Mr. Lisi claimed she was the owner at that time.").) The Loan Application to Washington Mutual Bank for the Cold Spring Harbor Property, dated October 23, 2007, was signed and entered into by and between Lanzilotta and another individual named Jason Higgins, as the alleged managing members of CBW. The Loan Application listed Lanzilotta as owning ninety-five percent of the Debtor and Higgins owning five percent. The Operating Agreement for the Cold Spring Harbor Property that was also presented to the bank, dated June 28, 2006, was signed and entered into by and between Lanzilotta and Higgins, as alleged members of CBW. However, according to the Debtor, the Operating Agreement is not legitimate and was not authorized by CBW. Moreover, in or about November 2010, Higgins testified that the signature on the Operating Agreement was not his. Therefore, the Debtor's position is that Lanzilotta procured the loan from Washington Mutual Bank in CBW's name, but was unauthorized to do so because Lisi was the real owner of the Debtor at the time of the mortgage application. At the time of the hearing, Lanzilotta had pled guilty to crime of fraud relating to the Washington Mutual Bank mortgage. (See Tr. at 11:3-6 ("THE COURT: So that [means] that the mortgage application and the loan application was fraudulent. MR. LESTER: Yes, sir. That's what Melissa Lanzilotta pled guilty to."); id. at 25:8-9 ("the argument I've said, Judge, is that Ms. Melissa Lanzilotta admitted that she committed a crime. She admitted that.").)

Although there is no dispute that some kind of mortgage fraud took place, in December 2008, the Suffolk County Supreme Court granted judgment to OBM in connection with the mortgage and authorized a foreclosure sale of the Cold Spring Harbor Property, based upon CBW's failure to make any payments on the mortgage for almost three years. The amount due to OBM under the judgment is more than $1,600,000. OBM is the Debtor's major secured creditor. However, on May 10, 2011, just hours before the foreclosure sale on the Cold Spring Harbor Property was to be held, CBW filed a Chapter 11 petition with the Bankruptcy Court through Kastaros, its current managing member and owner.

Katsaros claims that he currently owns one-hundred percent of the CBW's interests. However, the chain of ownership is not entirely clear. It appears that the entire ownership interest of the Debtor was originally held by one Elizabeth Dente. In or about early April 2008, Dente supposedly transferred her entire ownership interest in the company to Brandon Lisi. Then, on or about August 18, 2010, Lisi, as managing member and sole owner of the Debtor, allegedly transferred his entire interest in CBW to Katsaros, in satisfaction of approximately $100,000 owed to Katsaros by Lisi. At a deposition, Katsaros described the circumstances surrounding his acquisition of CBW. He testified as follows: (1) he met Lisi sometime in 2010, although he could not remember precisely when; (2) he lent Lisi approximately $100,000 over a few months, but could not recall when the loans were made; (3) he made these loans to Lisi with the knowledge that Lisi was under indictment; (4) the loans were made in cash in varying amounts from about $2,000 to about $5,000, from money that Katsaros "had around" from savings and cash loans he received from other parties; (5) he made the loans to Lisi without receiving any receipts or notes; (6) he did not know the exact amount loaned or keep any records as to the loaned amounts; and (7) he had no record of amounts he had borrowed in cash from others to make the loans to Lisi. Most importantly, Katsaros had no documentation to support the purported transfer of CBW from Lisi to him.

In the course of the bankruptcy proceeding, the Debtor was required to produce documents relating to: its Operating Agreement; the ownership of its interests; its dealings with Lisi and Dente; a proposed Chapter 11 plan; and any plans for future business. However, the only documents that the Debtor produced were blank standard forms for setting up an LLC. The Debtor has no income or assets to meet its current expenses including the payment of taxes and insurance on the properties, and no employees, tenants, or business to reorganize.

On July 1, 2011, the current Appellee, OBM, filed a motion with the Bankruptcy Court to dismiss the Chapter 11 case or, in the alternative, for relief from the automatic stay to permit OBM to conduct the scheduled foreclosure sale of the Cold Spring Harbor Property. OBM claimed that Katsaros was not the actual owner of the Cold Spring Harbor Property and thus could not file a Chapter 11 Bankruptcy petition seeking to reorganize with respect to that property. Moreover, OBM alleged that CBW's debt was tainted with fraud. CBW opposed the motion and argued that the Petition was properly filed by Katsaros, who had a one-hundred percent ownership interest in CBW. In particular, CBW asserted that the Petition had been filed in good faith with intent to reorganize, and that adequate post-petition mortgage payments were being made.

As stated above, on August 1, 2011, Judge Grossman held a hearing in connection with the OBM motion. Based upon his review of the papers and the oral arguments of counsel, the Bankruptcy Court granted the OBM motion and dismissed the case without prejudice pursuant to 11 U.S.C. § 1112(b). In particular, the Bankruptcy Court found that the Debtor had committed fraud in connection with the mortgage at its issuing date and thus had come to the Bankruptcy Court with unclean hands. The Bankruptcy Court stated, "this debtor was born, lived, operated, and now will die of fraud. It was created in a fraud. It existed in fraud. It's now trying to come back to life with some form of fraud. And it's not happening in this court." (Tr. at 37:15--18.) On August 4, 2011, the Bankruptcy Court entered an order dismissing the Chapter 11 Bankruptcy Case pursuant to 11 U.S.C. § 1112(b). (See Docket Entry No. 1-35.) Although the Bankruptcy Court expressly struck the "bad faith" language in the proposed order, this conduct nevertheless appears to be the basis of the court's dismissal.

On August 15, 2011, the Debtor filed the present appeal to this Court. According to the Appellant, the Bankruptcy Court's dismissal of the case pursuant to 11 U.S.C. ยง 1112(b) was clearly erroneous, mainly because: (1) it did not have any evidentiary basis for finding that the Debtor itself engaged in fraud, and relatedly did not hold an evidentiary hearing on the issue of the alleged bad faith of the Debtor; (2) it improperly blamed the Debtor for fraud that was committed by prior ...

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