In a setback for the District and the tenants of Terrace Manor—a dilapidated apartment complex owned and managed by Bethesda-based landlord Sanford Capital—a federal judge has rejected arguments that the ill-reputed company is abusing the bankruptcy process to sidestep its legal obligations at the Ward 8 property.

On Thursday, U.S. Bankruptcy Judge for D.C. S. Martin Teel Jr. threw out a motion to dismiss the Chapter 11 case for Terrace Manor, an 11-building property Attorney General Karl Racine has sued Sanford Capital over, alleging a pattern of neglect. Teel ruled that the District and the tenants, who supported the motion jointly, had not presented sufficient evidence to prove that the company is requesting bankruptcy “in bad faith.”

While the bankruptcy will continue in a series of hearings that will extend into June, yesterday’s decision means Sanford will be able to continue trying to sell Terrace Manor for $5.8 million to a third-party firm. Sanford purchased the property for $3.2 million in late 2012. 

The decision also suggests that D.C. landlords can withstand bankruptcy objections despite ongoing litigation in other courts, and may even profit on an accelerated timeline by getting around D.C.’s Tenant Opportunity to Purchase Act. That law has an exemption for owners going through bankruptcy. (Another District landlord, who was once sentenced to live in one of his deplorable apartment buildings, recently circumvented TOPA via bankruptcy court.)

Racine is currently suing Sanford Capital in D.C. Superior Court over conditions at two properties, including Terrace Manor. D.C.’s Department of Consumer and Regulatory Affairs has also cited the company with almost 1,100 housing code violations, totaling about $540,000 in potential fines, across its D.C. portfolio. Sanford has appealed all of those citations in administrative court.

Ruling from the bench Thursday, Judge Teel noted that the District and the tenants may yet defeat the bankruptcy action during the disclosure process, where a debtor lays out its financial affairs and reorganization strategy, by showing that the formal plan to offload the property “doesn’t comply with D.C. law.”

In this case, the prospective buyer, “subject to higher and better offers,” is a developer called Equilibrium. Equilibrium proposes to renovate Terrace Manor to the tune of $1.3 million—or about $20,000 per unit—according to bankruptcy filings.

After Sanford principal Aubrey Carter Nowell and Terrace Manor tenants’ association president Monica Jackson took the stand during cross-examination, Teel determined that it is “not clear there was a deliberate attempt to drive this property into the ground.” “Even if that’s what occurred,” he said, “the focus of bankruptcy is the interest of creditors,” or those to whom a debtor owes money, and “maximiz[ing the value of an] estate.”

A representative for EagleBank, the main lender for the property, told the court that bankruptcy “was in the best interest of all creditors” and would reduce financial uncertainty.

EagleBank provided Sanford with an original loan of $2.4 million to purchase the property, and its loan agreement stipulated that the property must be kept “in good condition.” By last May, D.C. had cited Sanford with 129 housing code violations at Terrace Manor—25 of which posed a “serious threat” to tenants’ safety—and 47 of 61 total apartments were vacant. Nonetheless, EagleBank increased the loan amount to $4.8 million that month. Ben Soto, who serves as Mayor Muriel Bowser’s campaign treasurer and sits on EagleBank’s board of directors, personally signed both loans as a notary public. His title company, Premium Title & Escrow, provided the title insurance.

Sanford Capital currently owes EagleBank more than $2.8 million, court documents state.

“I think this bankruptcy case is more likely to maximize the estate than if the case were dismissed,” Teel said. He added that he wasn’t convinced Sanford had intentionally hid pertinent information in an effort to mislead, and said it’s “not even clear there will be solvency” if D.C. or the tenants win civil claims against the company.

On the stand, Nowell said that his company brought in new tenants to only about three units at the property after they became vacant. When Sanford purchased Terrace Manor and promised to make repairs, over 50 units were occupied. “More people are no longer [there] because they were evicted, rather than they voluntarily left,” Nowell added.

Several other Sanford properties in D.C. are near fully occupied, despite similar building conditions. While many tenants pay market rate, a City Paper investigation found that the company receives at least $3.5 million a year in government-provided subsidies for low-income and formerly homeless tenants funded by taxpayers.

Sanford’s attorneys insisted that the parent company was no longer willing to “indefinitely” fund Terrace Manor and that, with only 13 occupied units producing roughly $9,500 a month in rental income, the property’s costs outweighed its gains. “They want to go back to the status quo of great uncertainty,” the company’s bankruptcy lawyer, Brent C. Strickland, told Judge Teel. “We want some resolution, some structure” to effectuate a sale.

Nowell told Strickland under oath that he’d “absolutely” consider a “higher and better” buying offer by the tenants, but later told a District attorney, Jimmy Rock, that some TOPA “due diligence documents [are] outstanding.” In TOPA cases, owners must provide tenants with floor plans, operating expenses, utility costs, and rent rolls.

In its arguments and court papers, the District pointed out that Nowell had neglected to disclose that Terrace Manor “poses or is alleged to pose a threat of imminent identifiable hazard to public health and safety.” It also argued that because Sanford Capital, as a parent company in which Nowell has an 85-percent stake, infused Terrace Manor with cash to cover operating costs in the past, it could do so in the future—and therefore there was no “legitimate financial stress” justifying bankruptcy. The U.S. Trustee, a part of the Department of Justice that works to ensure bankruptcy cases are appropriate, said it was concerned about dangers to public safety.

Part of Thursday’s proceedings revolved around a mold report commissioned by the tenants’ association that was based on an April 20 inspection. It found “fungal growth…in all areas” of several Terrace Manor buildings, but mentioned that management staff for Sanford were observed boarding up vacant units during the survey. Nowell testified that he was not notified about this inspection and wanted to make sure any empty apartments were secured, as they had been previously.

When asked by Rosa Evergreen, the attorney for the tenants’ association, why he was pursuing bankruptcy, Nowell responded twice that “it is my goal to sell the property.”

On the stand, Jackson, who has lived at Terrace Manor for about twenty years, said pests, flooding, and mold remain problems, among others. “Nothing much” happened after tenants brought these issues to the property management’s attention, she added. “I noticed there were times when we would have a court date or hearing, maintenance [staff] I had never seen before” would come and do work, but there were “no consistent repairs.”

Asked by the U.S. Trustee if it’s difficult to live in her apartment, Jackson said “very.” She responded “no” when asked if she believes it’s “habitable.” She also stated she has not met reps of the interested buyer, Equilibrium.

The Sanford affiliate that controls Terrace Manor, an LLC, applied for bankruptcy on March 30—about a week after the District had sought to hold Sanford Capital’s owner and its top property manager personally liable for damages in D.C.’s state-level court, and just one day before the District filed motions for receivership and civil contempt in that case. Racine’s office argued that Sanford had failed to comply with a rehabilitation plan for Terrace Manor that the parties struck in January. Last week, they reached a partial settlement, agreeing that a receiver—or an outside property manager—would bring Terrace Manor up to code and resolve any threats to the tenants’ health. The case is still active because D.C. is also advancing claims under consumer protection laws.

Nowell and Jackson declined to comment after the judge’s decision. A spokesman for Racine would only say that his office will keep fighting “to ensure the residents of Terrace Manor can live in safe, habitable housing.”

The next hearing on Terrace Manor LLC’s bankruptcy, which involves various motions, is set for Tuesday.