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August 8, 1978

In re CEDAR BAYOU, LTD., a Pennsylvania limited partnership, Debtor. Alfred A. SHAMAH, Steven J. Gumenick and Ronald J. Stark, Plaintiffs,
CEDAR BAYOU, LTD., Defendant

The opinion of the court was delivered by: SNYDER

This appeal is taken from a bankruptcy judge's decision that a bankruptcy court lacks jurisdiction to determine the validity of the creditor's lien in a Chapter XII real property arrangement when a creditor seeks to annul the automatic stay of his lien enforcement proceedings. The bankruptcy judge struck the debtor's answer containing defenses that disputed the lien as obtained through a course of fraud and disputed the irreparable harm alleged by the creditor, and then annulled the stay without hearing. We remand for hearing on relief from the automatic stay consistent with this Opinion.


 Chapter XII of the Bankruptcy Act, 11 U.S.C. § 801 Et seq., provides a means for financial rehabilitation of debtors, other than corporations, who are insolvent or unable to pay debts as they mature, 11 U.S.C. § 823, and whose debts are secured by real property, 11 U.S.C. § 861. A Chapter XII arrangement primarily involves creditors having a security interest in the debtor's real property, and may include all creditors secured and unsecured. 11 U.S.C. § 861. The statutory scheme is to keep the debtor in business during an arrangement under which all creditors are to be paid.

 The debtor initiates the Chapter XII process by filing a voluntary petition, 11 U.S.C. §§ 822, 823, through which the bankruptcy court obtains exclusive jurisdiction over the debtor and his property, wherever located, 11 U.S.C. § 811. The debtor continues in possession of the property, 11 U.S.C. § 844 (although in some cases the court may appoint a trustee, 11 U.S.C. § 832), and all lien enforcement proceedings against the debtor's property are automatically stayed to provide a period for investigation and review of the debtor's affairs to determine if rehabilitation is feasible and to enable him to formulate and present a workable plan of arrangement. 11 U.S.C. §§ 828, 907; Rule 12-43. The debtor then proposes a plan of arrangement, and the court reviews the plan at the meeting of creditors. Certain creditors may also propose a plan of arrangement. 11 U.S.C. § 866; Rule 12-36(b).

 A plan of arrangement may be confirmed when approved by the creditors of each class, holding two-thirds of the amount of the debts of such class, affected by the arrangement whose claims are proved and allowed. 11 U.S.C. § 868. If a creditor's debt is not listed as disputed or contingent, and no objection is made to allowance, his claim is deemed proved and allowed without his filing a proof of claim. Rule 12-30(a). However, if a debt is disputed by the debtor, the creditor must file a proof of claim within the time set by the court, or he will not be permitted to vote on the plan or share in distribution. Rule 12-30(b)(3). Chapter XII also contains a "cram-down" provision which binds affected but non-accepting creditors under the plan, so long as the dissenting creditors are otherwise adequately protected. 11 U.S.C. § 861(11).


 We glean from the parties that the Appellant-Debtor here, Cedar Bayou, Ltd., is a Pennsylvania limited partnership formed in 1974, as the investor partner in a joint venture in two garden apartment complexes in Baytown, Texas. According to Cedar Bayou's petition and civil complaint attached hereto, *fn1" the promoter-partner in the joint venture was a Texas limited partnership, Baytown, Ltd., also formed in 1974 by Appellee-Creditors Alfred Shamah and Steve Gumenick to operate the garden apartment venture. To raise money for the joint venture, 100 units of Cedar Bayou limited partnership interests were sold in October of 1974 to 25 investors in the Pittsburgh area for a total of $ 700,000.

 Both apartment complexes operated at substantial losses, and in February of 1976, Shamah and Gumenick made a personal loan of $ 206,062.72 to the joint venture to pay off second mortgages on the properties, the larger of the two complexes was turned over to the first mortgagee, and the joint venture continued to operate only the smaller complex. A demand note was given for the $ 206,062.72 loan, secured by a deed of trust in the apartment complex. The apartments continued to lose money, and, after the limited partners of Cedar Bayou rejected a proposed sale of the remaining apartment complex, Shamah and Gumenick sent the joint venture a notice of default on the demand note on January 14, 1977, and they proceeded to foreclose on the property in Texas.

 On September 22, 1977, prior to a scheduled foreclosure sale by the trustee appointed under the deed of trust (also an appellant here), Cedar Bayou filed an original Chapter XII petition in the Bankruptcy Court for the Western District of Pennsylvania, stating that it was insolvent and unable to pay debts as they matured. The Petition listed all known creditors, including Shamah and Gumenick, but disputed the validity of all the debts for the reasons stated in its civil complaint filed in the District Court for the Western District of Pennsylvania. The essence of that complaint was fraud in the transactions surrounding the joint venture and sale of Cedar Bayou limited partnership interests. *fn2"

 On September 27, 1977, the Bankruptcy Court sent all listed creditors notice of the Rule 12-43 automatic stay of lien enforcement proceedings. Shamah, Gumenick and the Deed of Trust Trustee thereupon filed a complaint to annul the Rule 12-43 stay of lien enforcement, alleging that Cedar Bayou was indebted to Shamah and Gumenick in the amount of $ 235,070.98 ($ 206,063.72 principal plus $ 29,008.26 unpaid interest) evidenced by the demand note and secured by deed of trust on the apartment complex, that foreclosure proceedings had been initiated and public auction scheduled, that stay of lien enforcement would cause them irreparable harm, that no plan of arrangement would be accepted by the creditors, and that the Chapter XII petition was filed solely to prevent the foreclosure sale and not out of desire for rehabilitation.

 Cedar Bayou answered the complaint to annul the stay, raising three defenses. First, it alleged that the requested relief could not be granted because Shamah and Gumenick had not filed a proof of claim. Second, it denied the validity of the debt and deed of trust, denied that irreparable harm would be caused by the stay, and denied that the Chapter XII petition was motivated by purposes other than rehabilitation. Third, it alleged that the demand note was obtained through a continuing course of fraud as detailed in its civil complaint.

 Shamah, Gumenick and the Trustee moved to strike the defenses in the answer, following which Cedar Bayou filed its own complaint in Bankruptcy Court under Rule 12-60(a)(2) to determine the validity of the lien. Concluding that on a creditor's complaint to annul the stay it had no jurisdiction over a debtor's challenges to the validity of the lien, rather than defenses going to the merits of lifting of the stay, the Bankruptcy Court granted the motion to strike defenses. It then vacated the automatic stay without hearing. Cedar Bayou appeals that decision.


 Affording the debtor a reprieve from lien enforcement proceedings is essential to the Chapter XII scheme of restoration. Unlike Chapter XI or straight bankruptcy proceedings, this Chapter is aimed at secured creditors and even provides a means to bind non-assenting secured creditors to a plan of arrangement. A creditor who could foreclose on an essential asset before acceptance of the plan could thus frustrate a debtor's opportunity to present an acceptable plan of arrangement and the very purpose of Chapter XII. On the other hand, a creditor precluded from his foreclosure remedies could suffer ...

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