In Re Brandywine River Hotel, Inc.

*11 OPINION STEPHEN RASLAVICH, Bankruptcy Judge. Introduction. Before the Court is a Motion of the above named debtor, Brandywine River Hotel, Inc. (“Brandywine Hotel”) seeking a determination that putative creditor Suburban Federal Savings Bank (“Suburban Federal”), has no interest in the revenues and/or rents generated from Brandywine Hotel’s operations or, in the alternative, for permission to use cash collateral pursuant to 11 U.S.C. § 363(c)(2)(B). The Motion, which challenges the existence of any interest in cash collateral on the part of Suburban Federal, is vigorously opposed by Suburban Federal which asserts that it does have an interest in cash collateral. Conversely, the challenge to the alleged cash collateral interest is supported by Meridian Bank (“Meridian”), the holder of a small secured claim which Bran-dywine agrees is secured, inter alio, by a cash collateral interest in rents from the hotel operation. The Motion was brought on an expedited basis shortly after the Chapter 11 filing. An initial evidentiary hearing was held on December 2, 1994. That hearing resulted in an interim consensual agreement for the use of cash collateral pending a further hearing on December 22, 1994. At the latter hearing, the parties agreed to the admission of a stipulated record, consisting of 40 numbered exhibits, for the resolution of the instant Motion. Brandywine Hotel, Suburban Federal and Meridian have all submitted post-hearing memoranda of law and the matter is now ripe for adjudication. Having considered the evidence and the arguments of counsel, the Court has concluded that Suburban Federal has failed to demonstrate that it has an interest in cash collateral of the Bankruptcy estate and that Brandywine Hotel may, therefore, utilize the subject business revenues free from Suburban Federal’s further claim to the contrary. Background. Brandywine Hotel is a Pennsylvania corporation, the sole shareholders, officers and directors of which are Paul A. Geary, Jr. and Ann Marie Geary, husband and wife. Bran-dywine Hotel operates a hotel on real property located at Route 1 and Route 100, Chadds Ford, Delaware County, Pennsylvania. The real property is owned by the Chadds Ford Partnership, a Pennsylvania general partnership, the sole partners of which are also Paul and Ann Marie Geary, (“CFP”). Brandywine Hotel operates its business pursuant to the terms of a written Lease Agreement with CFP dated August 1, 1987, as amended (the “Lease”). (Exhibits 22 and 22A). Suburban Federal is the holder of a first mortgage lien against the subject real estate and improvements (collectively “the Hotel Property”) as security for an August 7, 1986 loan to CFP in the original principal amount of $2,660,000. (Exhibits 1 and 2). Suburban Federal also holds a second mortgage lien against the Hotel Property as partial security for a separate loan made to CFP on May 26, 1987, in the original principal amount of $300,000 (Exhibits 3 and 4). (The $300,000 loan is also secured by a first mortgage lien on contiguous realty and improvements known as the Barn Shops). Both Suburban Federal loan transactions, as well as the Lease, were entered into on behalf of CFP by Paul Geary, Joseph Grace and Joseph Coyle. In or about April 1991, Paul Geary acquired the partnership interests of Grace and Coyle, whereupon CFP was reconstituted as a partnership between Paul Geary and his wife Ann Marie. To finance the acquisition of the partnership interests of Grace and Coyle the Gearys borrowed $650,000 from Constitution Bank, which loan is apparently secured by a third and fourth mortgage on the Hotel Property. Sometime in 1992, CFP fell into default with respect to payments due under the first and/or second mortgage loans with Suburban Federal. This led to the execution of a certain Modification Agreement, dated October 8, 1992, between Suburban Federal, the Gearys, CFP and Brandywine Hotel (the “Modification Agreement”). (Exhibit 5). Among the Modification Agreement’s principal features was a guaranty by the Gearys of the CFP indebtedness, a restructuring of the mortgage loan repayment terms, and consents by the Geary’s, CFP and Brandywine *12 Hotel to various financial covenants and restrictions with respect to the hotel operation. By late 1994, CFP was allegedly in default under the Modification Agreement, whereupon Suburban Federal commenced a civil action in the Court of Common Pleas of Delaware County against CFP based on the defaulted loans. Suburban Federal also named the Gearys and Brandywine Hotel as Defendants based on breaches of the Guaranty and financial covenants in the Modification Agreement. (Exhibit 38). Suburban Federal coupled with its Delaware County complaint an Emergency Petition for the appointment of a receiver for the affairs of both CFP and Brandywine Hotel. (Exhibit 39). The State Court granted the latter request and appointed as receiver an entity known as G.F. Management. That appointment of a receiver appears to have precipitated the initiation of this Chapter 11 case on November 23, 1994. At the initial hearing in this matter on December 2, 1994, Suburban Federal asserted an interest in cash collateral based essentially on two theories. First, Suburban Federal relied on the assignment of rents and profits language found in each of its mortgages from CFP. The pertinent language, set forth identically on the first page of each mortgage, provides as follows: Borrower does hereby mortgage, grant and convey to Lender the following described property located in Chadds Ford, Delaware County, Pennsylvania ... [reference to legal description] ... TOGETHER WITH, all the improvements now or hereafter erected on the property and all easements, rights, appurtenances, rents, royalties, mineral, oil and gas rights and profits, water rights, and stock and all fixtures now or hereafter a part of the property. All replacements and additions shall also be covered by this Security Instrument. The instant hotel room rents, it was urged to this Court, fall within the ambit of the above clause. Suburban Federal, in the second place, asserted that if the above argument failed to persuade by itself then, for a variety of reasons, including the present community of ownership between CFP and Brandywine Hotel, and an alleged disregard of corporate formalities, the Court should invoke what is sometimes referred to as the “mere instrumentality” doctrine, to treat the separate entities here (i.e., CFP and Brandywine Hotel) as one entity, and then give effect to the assignment of rentals language in the CFP/Suburban Federal Mortgages, citing Steven v. Roscoe Turner Aeronautical Corp., 324 F.2d 157 (7th Cir.1963); Fanfan v. Berwind Corporation, 362 F.Supp. 793 (E.D.Pa.1973). At the December 2, 1994 hearing, the Court expressed some doubt that the assignment of rentals clause in the mortgages would alone suffice to establish Suburban Federal’s interest for cash collateral purposes in any “rentals” other than the rent payable to CFP by Brandywine Hotel under the Lease. In other words, the Court did not view the assignment of rents language in the mortgage from CFP to Suburban Federal to permit the assignee, Suburban Federal, to look past the assignor CFP’s lease with Brandywine Hotel and cause the assignment to attach to the operating revenues of CFP’s tenant; at least not simply on the basis that because the tenant’s business was that of a hotel, its revenues were characterizable as rents and therefore fell within the sweep of the Landlord/mortgagee’s assignment of rents clause. The Court felt then, as it does now, that such a result would surely not follow if the tenant in question operated a retail store, or a service business, or any other type of business at the demised premises, and it does not concur with Suburban Federal that the result it desires should follow merely because of the type of business operated by its mortgagor’s tenant. Suburban Federal has not provided the Court with controlling authority for its aggressive proposition, nor has the Court’s own research identified such authority. In particular, the case of Bulger v. Wilderman, 101 Pa.Super. 168 (1931), originally cited as supportive of Suburban Federal’s position, is clearly inappo-site. In Bulger, the owner of an apartment complex defaulted under a mortgage containing an assignment of rents clause. The issue before that court was whether the owner/mortgagor’s subsequent reassignment of *13 one of the individual apartment leases undermined the validity or effectiveness of the mortgagee’s prior blanket assignment, such that a tenant who paid rent to the original mortgagee/assignee was nevertheless still liable for the same rent to the second assignee. The Bulger Court easily resolved that question in favor of the tenant, thereby upholding the primacy of the earlier in time blanket rent assignment. A situation analogous to Bulger would be one where CFP reassigned the lease between itself and Brandywine Hotel to a third party, which third party demanded that Brandywine Hotel pay to it rent under the Lease in derogation of Suburban Federal’s rights under the original mortgage assignment. Those facts are not present herein. CFP has not “re-assigned” the Lease to a third party. CFP’s tenant is simply using the property to operate a hotel. Again, therefore, the Court views Bulger as inapposite. Perhaps in recognition of this, Suburban Federal, at both the December 22, 1994 hearing and in its post-hearing legal memo-randa, conceded this issue. At this juncture, Suburban Federal argues exclusively that the facts and circumstances, as evidenced by the documentary record before the Court, are such that the Court should view CFP, Brandywine Hotel and the Geary’s individually, as one single economic unit. Upon careful contrast of the allegations made against the evidence presented, the Court is not satisfied that Suburban Federal has proved its case. The Court will, therefore, reject Suburban Federal’s assertion of an interest in cash collateral of Brandywine Hotel. As the Third Circuit Court of Appeals indicated in Kaplan v. First Options of Chicago, Inc., 19 F.3d 1503, 1521 (3rd Cir.1994), the alter ego concept is a “tool of equity [that] is appropriately utilized when the court must prevent fraud, illegality or injustice, or when recognition of the corporate entity would defeat public policy or shield someone from public liability for crime,” citing Carpenters Health & Welfare Fund v. Ken R. Ambrose, Inc., 727 F.2d 279, 284 (3d Cir.1983). The corporate veil is pierced only when “the corporation was an artifice and a sham to execute illegitimate purposes and [an] abuse of the corporate fiction and immunity that it carries.” Wheeling-Pittsburgh v. Intersteel, Inc., 758 F.Supp. 1054, 1058 (W.D.Pa.1990), citing Zubik v. Zubik, 384 F.2d 267 (3d Cir.1967), cert. denied, 390 U.S. 988, 88 S.Ct. 1183, 19 L.Ed.2d 1291 (1968). Events that permit the corporate veil to be pierced include: “failure to observe corporate formalities, non-payment of dividends, insolvency of the debtor corporation at the time, siphoning of funds of the corporation by the dominant shareholder, non-functioning of their officers or directors, absence of corporate records, and the fact that the corporation is merely a facade for the operations of the dominant stockholder of stockholders.” United States v. Pisani, 646 F.2d 83, 88 (3d Cir.1981), quoting DeWitt Truck Brokers v. W. Ray Flemming Fruit Co., 540 F.2d 681, 686-87 (4th Cir.1976). In addition, courts sometimes consider undercapitalization. Id. Not every disregard of corporate formalities or failure to maintain corporate records, however, justifies piercing the corporate veil. That remedy is available only if it is also shown that a corporation’s affairs and personnel were manipulated to such an extent that it became nothing more than a sham used to disguise that alter ego’s use of its assets for his own benefit in fraud of its creditors. In short, the evidence must show that the corporation’s owners abused the legal separation of a corporation’s owners, and used the corporation for illegitimate purposes. See Zubik, 348 F.2d at 270 n. 2. Suburban Federal’s “mere instrumentality” allegation’s fall into a number of categories. In addition to the customary assertions that the subject entities failed to observe the requisite corporate formalities, and that the principals themselves treated the separate entities as one, Suburban Federal focuses on an April 1991 amendment to the Lease pursuant to which the Gearys reduced the rent payable from Brandywine Hotel to CFP. Since CFP has no business other than its ownership of the Hotel Property and the Barn Shops, CFP’s only source of income is rent. The aforesaid reduction in Brandywine Hotel’s rent apparently created a situation *14 where on the face of things CFP’s income from rentals was insufficient to service the Suburban Federal and Constitution Bank debts. To meet mortgage payments and thus avoid default, the Gearys, it is argued, would have to resort to use of funds from the Hotel operations. Their willingness to engage in this sort of “commingling,” Suburban Federal maintains, warrants treating CFP and Brandywine as a single enterprise. There is a degree of appeal to Suburban Federal’s arguments but ultimately they fail to persuade. Suburban Federal has always been aware of the bifurcated ownership interests of the realty versus the hotel business because this state of affairs existed at the time the Suburban Federal loans were made. Although there may have been the alleged commingling of funds, it occurred, if at all, only to some small degree. Alternatively, one might argue, the Gearys could have withdrawn funds from Brandywine Hotel in the form of dividends to themselves and “invested” those funds in CFP to enable it to make rental payments. This course might have produced other problems of its own, if, for instance, Brandywine Hotel were unable to pay its own creditors. While not endorsing the “dividend” approach, that alternative is worth noting, if only to indicate that the Gearys use of excess revenues from the Hotel operation in the fashion described does not strike the Court as especially egregious, since they possibly might have reached them anyway. Similarly, while the Gearys attention to corporate “formalities” perhaps waned as their financial difficulties increased the record before this Court falls far short of evidencing the type of “sham” or “facade” which demands disregard of the separate existence of the two business entities. Certainly there is no “smoking gun” in this regard. There is, for example, no evidence that CFP and Brandywine Hotel do not each file their own separate tax returns or keep separate books. Numerous separate annual financial statements for each entity are contained in the Exhibit binder (See Ex. 31-35), and while these statements reflect declining profitability, that in itself is not evidence of the existence of an artifice to defraud Suburban Federal or anyone else. Likewise, the amendment to the Lease permits no automatic conclusion of wrongdoing on the part of the Gearys, especially in the absence of other evidence confirming the alleged “below market” nature of the lease. If there was going to be a shortfall for CFP from rent collection, it could simply mean no more than that the Gearys would have to invest their own funds in CFP, presumably through profit distributions to them by Bran-dywine Hotel. It is also important in this regard to note that Suburban Federal’s ability to exercise its state law collection rights was not affected by any of the acts and/or omissions of which Suburban Federal complains in this context. On the contrary, if CFP defaulted under the subject mortgages, the Bank could simply proceed to foreclosure. No argument to the contrary is made herein. Instead, Suburban Federal’s principal grievance seems to be with the filing of the Bankruptcy itself, for that event has intruded on its rights to move forward, especially now that CFP has also filed for relief under Chapter 11. It is mainly the Bankruptcy filing and its cash collateral implications, coupled with the absence of a direct borrower/lender relationship between Suburban Federal and Brandywine Hotel, which impels Suburban Federal to argue for disregard of the distinction between the two entities. The Court appreciates Suburban Federal’s anxiety over the repayment of the mortgage indebtedness. For a Bank its size this is apparently a relatively large problem loan. The Court notes too that Suburban Federal is moving forward aggressively in this Court, both by way of the instant motion, as well as with pending motions to dismiss the case and/or for relief from the automatic stay under 11 U.S.C. § 362. Without commenting on the merits of those other Motions, the Court will, at this juncture, merely indicate that, as the party with the burden of proof in the context of “piercing the corporate veil,” 1 Suburban Federal has failed to satisfy the Court that it should take the rather drastic step of collapsing CFP and Brandywine Hotel into one entity. For the *15 foregoing reasons, the Debtor’s Motion seeking a determination that Suburban Federal has no interest in the revenues and/or rents generated by the Debtor’s operations will be granted. Accordingly, the alternative relief sought by the Debtor, for approval of use of cash collateral becomes moot. In light of the above disposition it is not necessary to reach an additional issue discussed in their memoranda by Meridian, Brandywine Hotel, and Suburban Federal, however, brief mention of it is appropriate. Specifically, Meridian and Brandywine Hotel, both argue that, even if the corporate veil were pierced in this instance, Suburban Federal’s claim to an interest in cash collateral must still be rejected because the pertinent language of its rent assignment clause does not encompass the hotel revenues at stake herein. (See description at Page 4, supra) In this regard, neither Meridian nor Brandy-wine Hotel overlooks the relevant amendments enacted at Section 214 of the recent Bankruptcy Reform Act of 1994. (the “Reform Act”). 2 These amendments, it is duly noted, refine the term “cash collateral” as used in 11 U.S.C. § 363, to include the “fees, charges, accounts or other payments for the use or occupancy of rooms and other public facilities in hotels, motels or other lodging properties” (collectively “Hotel Revenues”). Rather, Meridian and Brandywine Hotel argue, that the effect of the amendments is simply to permit a lender with a valid, but possibly less than fully perfected pre-petition security interest in Hotel Revenues, to now assert that such interest is preserved post-petition and that the Hotel Revenues constitute cash collateral. In this instance, Meridian and Brandywine Hotel both argue that Suburban Federal does not have a valid pre-petition security interest in Hotel Revenues because the assignment language in its mortgages includes only “rents, royalties, mineral, oil and gas rights and profits ...” In other words, Meridian and Brandywine Hotel argue that the assignment language in question would have to include specific reference to “fees, charges, accounts or other payments for the use or occupancy of rooms ... etc.” In this respect Meridian and Brandywine rely on this Court’s own recent holding in In re West Chestnut Realty of Haverford, Inc., 166 B.R. 53, 55-56 (Bankr.E.D.Pa.1993), aff’d, 173 B.R. 322, 324 (E.D.Pa.1994) wherein the Court sided with the majority of Courts nationwide in holding that hotel room charges are neither rentals nor profits of realty as that phrase is commonly understood in real estate parlance but are, rather, an interest of a different sort, possibly one subject to the perfection provisions of Article 9 of the U.C.C. The Reform Act, it is urged, did not alter this fact by expanding the definition of the term “rents.” Suburban Federal, takes issue with the foregoing and insists that the Reform Act’s revisions to Sections 363 and 552(b) of the Bankruptcy Code are specifically intended to deal with circumstances such as those found herein. As noted, the Court’s adverse finding on the corporate veil issue makes a determination of this issue unnecessary. However, the Court will indicate that it considers the arguments of Meridian and Bran-dywine Hotel in this regard to be convincing. There seems little question that the Reform Act was intended to include hotel rents in the category of assets which now constitute cash collateral and, furthermore, to additionally extend the same protection to hotel rents as is now extended to realty rents and profits; that is, by preserving that interest post-petition even where it has not been fully perfected under applicable state law say, for instance, due to a failure to deliver demand notices to tenants. It is less clear that the intention of Section 214 of the Reform Act is to completely eliminate any state law distinction between “rents” and “hotel revenues” such that an existing security instrument which makes reference to one asset is now automatically deemed to include the other. The legislative history of Section 214 does not support this conclusion 3 and given the recent passage of the Reform Act there is apparently yet no case law on the question. Suffice it to say that Suburban Federal’s argument in this respect requires inferences that this Court is doubtful it would be pre *16 pared to make had a different result obtained on the issues hereinbefore addressed. Footnotes [1] See In re Nahas, 161 B.R. 927 (W.D.Pa.1979). [2] Pub.L. 103-394, 1994. [3] 140 Cong.Rec. H10752-01, *H10768. *29 chapter 11 administrative expenses is that little or nothing will be available for distribution to chapter 11 administrative claimants after distribution is made for chapter 7 administrative expenses.