The owners of a boutique hotel in Brooklyn and its management company must return pandemic-era refundable tax credits that they received as the hotel filed for Chapter 11 bankruptcy protection, a New York bankruptcy judge ruled, saying they had unfairly pocketed the money at the bankruptcy estate's expense.

In a ruling Friday, Judge Sean H. Lane found that the owners of The Williamsburg Hotel along with its manager, The Williamsburg Hotel BK LLC, were "unjustly enriched" in taking more than $1.5 million in employee retention tax credits for 2021, the year the limited liability company that owned the hotel filed for bankruptcy.

The hotel manager collected the hotel's revenue and employed its workers, making payroll and paying taxes, the judge said. The taxes that were returned in the form of the ERTC refunds came from hotel revenue, so "it would logically follow that the ERTC refunds are property of the debtor's estate," Judge Lane said.

The judge found that the manager and its owners, Toby Moskovits and Michael Lichetenstein, used property that belonged to the estate to pay the management company's taxes.

"In doing so, the defendants harmed the debtor and its estate by exercising control over the property of the estate that would have been distributed among creditors," the judge said.

Moskovits and Lichetenstein own both the manager LLC and another one that owned the hotel and filed for bankruptcy protection in February 2021, called 96 Wythe Acquisition LLC. After the filing, a partnership that had lent money to the hotel asked the court to appoint an examiner, who found that Moskovits and Lichtenstein "were running the bankruptcy case for their own benefit, as opposed to the benefit of all creditors," according to the ruling.

The court then appointed a trustee, Stephen S. Gray, to oversee the bankruptcy estate.

Friday's ruling granted summary judgment to Gray, who had filed an adversary proceeding seeking to force Moskovits, Lichtenstein and their manager LLC to pay him the pandemic refunds for the estate's benefit.

The defendants argued there was a separate contract between the two LLCs that barred Gray's claim that they had unfairly enriched themselves in keeping and using the tax refunds. But Judge Lane found that Moskovits, Lichtenstein and their manager LLC "neither provided a copy of any such separate agreement on the subject nor identified where one could be located."

Moskovits, Lichtenstein and their manager LLC also argued that they were entitled to keep the ERTC refunds to pay for management fees and shortfalls they claimed they covered, according to the ruling. They said the trustee did not show that the money would have been used to reimburse them for the costs of operating the hotel.

But the judge found their claims "inconsistent with core bankruptcy principles" in which creditors are paid according to a priority system meant to treat all the creditors equally.

The manager LLC "engaged in impermissible self-help by paying itself directly as opposed to being paid through in the bankruptcy case in 'bankruptcy dollars,' consistent with the recovery of other creditors," Judge Lane said.

In the final paragraph of his ruling, the judge noted that the handling of the ERTC by Moskovits, Lichtenstein and the manager LLC was typical behavior for them, saying they had also tried to retain the hotel's intellectual property.

"The court does not take such conduct lightly, particularly as it greatly increases the costs associated with the administrating of this case at the expense of creditor recovery," the judge said.

Of the $1.5 million total received in ERTC refunds, about $475,000 — the portion paid out by the IRS for the second quarter of 2021 — remains in escrow held by counsel for Moskovits, Lichtenstein and the manager LLC, according to the ruling.

Williamsburg Hotel was a five-star boutique hospitality business with a rooftop bar and restaurant located by the waterfront in north Brooklyn. At the time of its bankruptcy filing, it estimated its liabilities at nearly $80 million.

The bankruptcy court later put the property up for auction, and the hotel was sold to Quadrum Global, a private equity and development company, for $96 million, court filings show. Quadrum Global planned to operate the property under a new name, Arlo Williamsburg, which has since opened.

Counsel for Gray did not immediately respond to a request for comment.

Counsel for The Williamsburg Hotel BK, Mozkovits and Lichtenstein did not immediately respond to a request for comment.

Gray is represented by Neil Matthew Berger, Frank A. Oswald of Togut Segal & Segal LLP and by Richard S. Mandel of Cowan Liebowitz & Latman.

The Williamsburg Hotel BK, Mozkovits and Lichtenstein are represented by Fern Flomenhaft.

The case is In re: 96 Wythe Acquisition LLC v. Stephen S. Gray v. The Williamsburg Hotel BK LLC et al., case numbers 21-22108 and 22-07048, in the U.S. Bankruptcy Court of the Southern District of New York.