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Pursuant to Section 1112(b) of the Bankruptcy Code, a chapter 11 petition may be dismissed for cause if it appears that the petition was not filed in good faith. Marsch v. Marsch (In re Marsch), 36 F.3d 825, 828 (9th Cir.1994).  A chapter 11 petition is not filed in good faith if it represents an attempt “to unreasonably deter and harass creditors” and to “achieve objectives outside the legitimate scope of the bankruptcy laws.” Id. at 828.  Good faith is lacking only when the debtor’s actions are a clear abuse of the bankruptcy process.

In In re Clinton Centrifuge, Inc., 72 B.R. 900 (Bankr. E.D.Pa. 1987), the court addressed of whether a case should be dismissed in the context of a debtor seeking to avoid posting a supersedeas bond.  It held that mere fact that the Chapter 11 filing was triggered by state court proceeding adverse to debtor did not constitute, by itself, “bad faith” warranting dismissal of Chapter 11 case. Id. at 908.  The court reviewed case law on the topic and noted that in evaluating good faith, the courts “all engaged, in varying degrees, in an ‘on-the-spot evaluation of the debtor’s financial condition, motives, and the local financial realities.’” Id. at 906.  The cases which were dismissed for bad faith involved either an infeasible plan of reorganization, or the debtor lacked little, if any, intent to truly reorganize. Id. at 907.

In re Chu, 253 B.R. 92 (S.D.Cal. 2000) stands for the proposition that “cause” exists to convert a Chapter 11 case to one under Chapter 7 based on the debtor’s “bad faith” if the petition was filed to avoid having to post a supersedeas bond following entry of a state court judgment.  However, the court noted that the debtor could not propose a reorganization plan with any likelihood of being confirmed and had little debt except that which was owed to the judgment creditor.

In re Slettelland, 260 B.R. 657 (Bankr. S.D.N.Y. 2001) provided a detailed analysis of when it was appropriate to dismiss a case on the basis of bad faith when the debtor seeks to avoid posting a supersedeas bond.  First, the court noted that the mere fact that the debtor sought to avoid the payment of the supersedeas bond was not enough. Rather, the court required that a series of factors be considered.  They are as follows:

  1. The ability to post a bond and/or pay the judgment. The court held that a case should be dismissed as a bad faith filing if the Chapter 11 debtor was able to pay the judgment or post the bond.
  2. The transfer of assets beyond the reach of creditors. The court held that a debtor’s decision to transfer assets or place them beyond the reach of creditors was the core reason for finding the debtor in bad faith whether or not the debtor was seeking to avoid the effects of a judgment.
  3. Case is a two-party dispute between the debtor and the judgment creditor, debtor has no employees or ongoing business. The court held that whether a debtor has a business to reorganize has been an important factor in many cases in deciding whether to dismiss the petition as a bad faith filing. The crucial element to the finding of good faith has been the fact that the debtor was an on-going concern with employees and the means to reorganize.
  4. The debtor has not exhausted its state remedies in attempting to appeal without posting the bond; availability of alternatives to bankruptcy filing. The court held that several courts have been influenced by the possibility that the debtor might be able to appeal without posting a bond or with a limited bond. In other words, the requirement should be whether the debtors failed to apply to the state court for the right to file an appeal bond “commensurate with their financial ability,” as may be possible under applicable state law.
  5. Attempt to relitigate. The court held that it was appropriate to refuse to permit a debtor who have filed a bankruptcy petition to “relitigate” a state judgment.

Applying the above factors, Slettelland refused to dismiss the Chapter 11 petition as a bad faith filing. The court noted that the debtor did not transfer assets or take any other action to hinder or delay creditors prior to filing its bankruptcy case. Further, the party moving to dismiss the case did not argue that the debtor had the means to pay the judgment or obtain an appeal bond. Additionally, the court noted that the debtor was engaged in a “business” but had no employees. That latter fact, the court decided was not outcome determinative.

Finally, the court stated that whether the case was a two-party contest between the debtor and the judgment creditor, and the fact that there were few creditors, made it appropriate to examine whether there is in fact a need for a Chapter 11 case, i.e., was the debtor is attempting to stall one creditor and was the state court a “preferable forum.” Under the facts of the Slettelland, where there were few creditors, the court noted that there was no attempt on the part of the debtor to relitigate or forum shop, nor would the bankruptcy court have to decide matters being litigated elsewhere. Two other important factors in bad faith dismissals was whether the debtor could post a bond and whether the costs of appeal were accruing as priority claims. In some cases, the debtor’s financial condition may be deteriorating so quickly that creditor could not fairly be stayed from executing on its judgment, or the debtor may be required to provide them with adequate protection as a condition to pursue the appeal. However, the court held that these issues are more appropriately considered in connection with a motion to modify the automatic stay.

In In re Dilling, 322 B.R. 353 (Bankr. N.D.Ill. 2005) the court refused to dismiss a bankruptcy even though it was filed in part to allow the debtor to purse an appeal without a supersedeas bond. In this regard, the court placed great weight on the fact that the judgment against the debtor was novel. As a result, the court determined that it was not unreasonable to conclude that the debtor’s appeal might succeed. Id. at 360. The court further explained its ruling as follows:

If this bankruptcy is dismissed, Doe can collect close to the full amount of her judgment by forcing the sale of Dilling’s assets, including three rental properties, and her personal residence. This is likely to occur before Dilling’s appeal is resolved and may result in rapid liquidation of illiquid assets that will not maximize their value. Moreover, if this case is dismissed or converted to a chapter 7, which would result in a near total liquidation and payment to Doe, Dilling, an elderly woman, may never be able to restore her financial situation to the status quo. Even if Dilling could recover funds that Doe executed on and the substantial sum that is likely to be paid to Doe’s attorneys, funds recovered may never compensate Dilling for losses arising due to the forced sale of her home, three properties and other securities. “Certain assets of Debtor are worth more if liquidated in an orderly and controlled manner rather than at a forced sale. Id. at 361.

The court further noted that this was not the type of case where the debtor had enough assets to pay the judgment, but instead preferred bankruptcy to try and collaterally attack the judgment and avoid posting an appeal bond. The debtor was appealing the judgment in state court and was not using the bankruptcy as a litigation tactic to foil state court procedures.  Finally, the court noted that there was little doubt that the Debtor could not get an appeal bond. “It is generally accepted that a bankruptcy case will not be dismissed, even when used as a substitute for an appeal bond, when the debtor has made diligent efforts to post such a bond but failed. Id. at 362.

In In re Mickler, 324 B.R. 613 (Bankr. W.D.Ky. 2005) the debtor filed a Chapter 11 petition while he was appealing a Family Court ruling with respect to equalization payments and alimony. In dismissing this case as one filed in bad faith, the court noted that it “should not, and will not, act as a substitute for a supersedeas bond of state court proceedings.” Id. at 618. It should be noted, however, that this case had a number of problems, including factual misrepresentations and omissions on the debtor’s bankruptcy schedules.

In In re the Bridge to Life, Inc., 330 B.R. 351 (Bankr. E.D.N.Y. 2005) the debtor refiled its Chapter 11 petition, in violation of an injunctive provision in the order dismissing his prior bankruptcy case. Id. at 355. The debtor had no creditors other than judgment creditor that were pressing debtor for payment. Id. at 357.  The court found that the debtor had refiled its bankruptcy petition in order to avoid having to post the supersedeas bond while appealing the state court judgment. Id.  The court also noted that the debtor had the ability to pay the bond, and that the refiling of its bankruptcy petition was purely a litigation tactic to obtain an alternative forum for resolution of the state law dispute with the judgment creditor. Id.

In In re Zaruba, 2007 WL 4589746 (Bankr. D.Alaska, Dec. 28, 2007) the court held that the debtors’ Chapter 11 filings were not made in bad faith because the debtor lacked the ability to post an appeal bond without significant business impairment. Id. at *3.  The court based its decision on the fact the debtor was still operating a business, the debtor could not satisfy the state court judgment from non-business assets, the evidence did not indicate that the debtors filed the bankruptcy petition in an attempt to delay the appeal or harass creditors, the debtors had contributed significant assets to their reorganization effort, and their plans contemplated a “worst case” scenario which assumed the state court award would be upheld. Id. at *4.

In In re Marshall, 403 B.R. 668 (C.D.Cal. 2009) the court held that the filing of Chapter 11 petition by allegedly solvent debtors who, with exception of multimillion dollar fraud judgment entered against them, did not have substantial unsecured debt relative to their considerable assets was not in bad faith. The court found that the evidence, especially the fact that the debtors did not have sufficient liquid assets to pay the supersedeas bond, supported the conclusion that the debtors did not seek to unreasonably deter or hinder creditors through abuse of the bankruptcy process.

In In re Autterson, 2016 WL 1039592 (Bankr. D.Colo.), the court, while not dealing with the issue of supersedeas bonds, noted that “debtors often file for bankruptcy protection after suffering adverse judgments.”  The court stated that:

The Court does not suggest that such post-judgment bankruptcy filings, by themselves, establish bad faith. See In re Experient Corp., 535 B.R. 386, 410–11 (Bankr.D.Colo.2015) (“[Debtor’s management] openly testified that the reason [debtor] filed for bankruptcy relief was [a] state court judgment. However, this alone is not indicative of bad faith.”).  Quite to the contrary, adverse litigation results may justify bankruptcy as a mechanism to fairly pay creditors and allow reorganization consistent with the Bankruptcy Code.

In In re Hanna, 2018 WL 1770960 (9th Cir.BAP, April 13, 2018), creditors argued that the case should be dismissed as a bad faith filing because: (i) the debtors were solvent at the time of the filing; (ii) they had few unsecured creditors; and (iii) the debtors admitted at the §341(a) meeting of creditors that the judgment and the debtors’ inability to obtain a supersedeas bond was what led them to file for bankruptcy. The creditors argued that the debtors had the ability to obtain the bond based on their net worth.  Lastly, the creditors argued that the debtors were using the Chapter 11 case as a free stay and as a litigation tactic to delay paying the judgment, as evidenced by debtors’ admission that, had they not filed for bankruptcy, the creditors would have seized their assets to satisfy the Judgment.

The court started its analysis by noting that “neither the Ninth Circuit Court of Appeals nor this Panel has held that filing a bankruptcy petition in lieu of posting an appeal bond is ipso facto bad faith for purposes of dismissal under §1112(b).” Id. at *5.  The court then addressed each of the creditors arguments.  First, it noted that in this case, the bankruptcy court found that even if the debtors had obtained a supersedeas bond, the creditors would not have been able to collect on the judgment until the appeal was finally resolved. It concluded, therefore, that the debtors’ bankruptcy filing was not an attempt to unreasonably deter and harass creditors; instead, they were attempting to effect a speedy, efficient reorganization on a feasible basis.  The inclusion of the judgment in their plan suggested that they filed their bankruptcy petition for the proper purpose of reorganization, not as a mere ploy to avoid posting a bond. Id.

Next, [the creditors argue] that the [debtors’] bankruptcy case was filed for the improper purpose of obtaining a stay of the state court litigation.  The automatic stay under §362 “is intended to provide debtors in bankruptcy with a breathing spell from their creditors’ collection actions.  And it is not unusual to encounter a chapter 11 case ‘because of the crushing weight of a judgment.’  Again, the bankruptcy court found that the [debtors’] petition was not filed to unreasonably deter and harass creditors; it was filed so that their creditors could be paid in an orderly fashion and without sacrificing equity.  The goal of orderly payment of creditors is one of the legitimate reasons to file bankruptcy.

The [creditors were very aggressive in their judgment collection efforts and had a substantial advantage over other creditors with their judgment lien, which was obtained within the preference period and which the [debtors] were seeking to avoid.  The [debtors’] petition not only appropriately provided them a breathing spell, it laid the ground work for another key goal underlying the bankruptcy process – leveling the playing field for other creditors.

Id. at *6.

The court concluded that preventing creditors from seizing all liquid assets ahead of other creditors and bringing preferential transfers back into the estate for the benefit of all creditors was consistent with the primary goals of the bankruptcy process.  The creditors’ argument was further undermined by the fact that, just two weeks after they filed their Chapter 11 case, the debtors sought relief from stay to proceed with the appeal of the judgment.  According to the court, this clearly revealed that the debtors were not intending to stall or delay that process by filing their bankruptcy petition. Id. at *6.

 

Matthew T. Gensburg
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