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SulmeyerKupetz
Los Angeles, California
In their article, Courts Reign in Solvent Debtor Bankruptcies by Handing Landlords Significant Victories, Norton Bankruptcy Adviser, May 2005, John D. Fredericks and Eric E. Sagerman argue that In re Liberate Technologies, 314 B.R. 206 (Bankr. N.D. Cal. 2004), and NMSBPCSLDHB, L.P. v. Integrated Telecom Express, Inc. (In re Integrated Telecom Express, Inc.), 384 F.3d 108 (3rd Cir. 2004), cert denied, 73 U.S.L.W. 3540 (Feb. 22, 2005), reflect a trend away from prior cases that allowed solvent debtors to reorganize (see below). As explained here, these recent decisions depart from a long line of cases holding that a debtor’s good faith should be determined from a “totality of circumstances” -- including solvency of the debtor -- but not determined exclusively by the debtor’s solvency. Further, this excessive focus on the debtor’s solvency creates an additional eligibility requirement not found in § 109(d) and (e). It is too soon to declare that the courts have shifted away or abandoned the “totality of circumstances” approach and instead adopted the holdings in Liberate and Integrated.
The requirement that a plan be filed in “good faith” is mentioned in both § 1129 and § 1325 (Chapter 12 also has a good faith requirement which is found at § 1225 (a)(3). The language is identical to § 1325(a)(3)).
Section 1129 (a) states in part that a court shall confirm a plan only if all of the following requirements are met: (3) The plan has been proposed in good faith and not by any means forbidden by law. Section 1325 (a) states in part that except as provided in subsection (b), the court shall confirm a plan if-(3) the plan has been proposed in good faith and not by any means forbidden by law.
Lack of good faith is conspicuously absent from the Code sections describing appropriate “cause” to dismiss or convert a chapter 13 or chapter 11 filing. See §§ 1112(b) and 1307(c). Courts have generally found that a petition must be filed in good faith whenever a debtor is seeking the rehabilitative goals of chapter 11, finding that it is necessary that the debtor show that its filing presupposes a “valid reorganizational purpose.” In re SGL Carbon Corp., 200 F.3d 154, 164 (3rd Cir. 1999). Even though “good faith” is not listed in sections 1112 and 1307, courts have found an implicit requirement that petitions be filed in good faith and that a court may use its equitable power to prevent a misuse or abuse of the rehabilitative provisions of chapters 11 and 13. In re Adell, 310 B.R. 460, 465 (Bankr. M.D. Fla. 2004); In re Alt, 305 F.3d 413 (6th Cir. 2002). (There are several cases which have found that chapter 7 does not have a similar good faith requirement. See In re Padilla, 222 F.3d 1184, 1193 (9th Cir. 2000)). Courts have generally employed a “totality of circumstances” test when determining whether a petition has been filed in good faith. See Generally, (Chapter 11) Finney v. Smith, 992 F.2d 43 (4th Cir. 1993); In re Winslow, 949 F.2d 401 (10th Cir. 1991); (Chapter 13) In re Leavitt, 171 F.3d 1219 (9th Cir. 1999); In re Love, 957 f.2d 1350, 1357 (7th Cir. 1992).
Two recent courts have dismissed petitions not based on a “totality of circumstances” analysis, but instead dismissed petitions as bad faith filings on the sole fact that a debtor is solvent. Are these decisions creating a “per se” rule that a solvent debtor is precluded from filing a good faith petition for reorganization and therefore inserting an additional requirement to be eligible for reorganization under chapter 11 or chapter 13?
It is well established that a debtor need not be insolvent before filing for bankruptcy protection. SGL Carbon, 200 F.3d 154, 163 (3rd Cir. 1999). The Code does not require specific evidence of insolvency for a voluntary chapter 11 filing. In re Mid-Valley, Inc., 305 B.R. 425, 430 (Bankr. W.D. Pa. 2004). In the past, courts have considered a debtor’s solvency as a factor in determining whether or not a petition is filed in good faith. See SGL Carbon. Recently, two courts have abandoned the “totality of circumstances” test and focused on a debtor’s solvency exclusively to determine whether or not a petition is filed in good faith.
In the case of In re Liberate Technologies, 314 B.R. 206 (Bankr. N.D. Cal. 2004), the debtor had over $212 million of unrestricted cash on hand at the time it filed its chapter 11 petition. The debtor sought to cap a landlord’s claim at $8 million from the $45 million scheduled claim pursuant to § 502(b)(6). The Court in analyzing whether or not the petition was filed in good faith stated that the most conspicuous prerequisite for obtaining chapter 11 bankruptcy relief is that the debtor need chapter 11 relief. Liberate 314 B.R. at 211. It further held that a case could not be found to have been filed in good faith if the sole purpose of the solvent debtor’s filing was to take advantage of a particular section of the Code (here, § 502(b)(6)). Liberate 314 B.R. at 216.
The Third Circuit reached a similar conclusion in NMSBPCSLDHB, L.P. v. Integrated Telecom Express, Inc. (In re Integrated Telecom Express, Inc.), 384 F.3d 108 (3rd Cir. 2004), cert denied, 73 U.S.L.W. 3540 (Feb. 22, 2005). In this case the debtor had over $105 million in cash which exceeded its liabilities by over $70 million. Again, the debtor sought to cap a landlord’s claim from $26 million to $4.3 million. The Third Circuit found that the bankruptcy filing was in bad faith because the debtor did not have any financial distress because it was solvent. Integrated 384 F.3d at 122. The Court further based its finding on the fact that the filing of the petition did not maximize value for creditors as a whole, but instead facilitated dissolution on terms favorable to equity interests. Integrated 384 F.3d at 126. Lastly the court stated “To be filed in good faith, a petition must do more than merely invoke some distributional mechanism in the Bankruptcy Code. It must seek to create or preserve some value that would otherwise be lost-not merely distributed to a different stakeholder-outside of bankruptcy. Integrated 384 F.3d at 129.
The Liberate and Integrated Telecom decisions remain the minority decisions, with other courts continuing to allow solvent debtors to seek bankruptcy protection to reorganize under the Code.
In the case of In re Chameleon Systems, Inc., 306 B.R. 666 (Bankr. N.D. Cal. 2004), the court held that a solvent debtor (one which had enough cash to cover its liabilities) could file a bankruptcy petition to cap a landlord’s claim under § 502(b)(6), noting that “there is no reason [the debtor] should remain in operation for the sole purpose of servicing this lease.” Chameleon, 306 B.R. at 672.
The court in Solow v. PPI Enterprises (U.S.), Inc. (In re PPI Enterprises (U.S.), Inc.), 324 F.3d 197 (3rd Cir. 2003), which discussed the relevancy of a solvency of a chapter 11 debtor wherein it sought to limit a landlord’s claim under § 502(b)(6). The Third Circuit which later decided Integrated Telecom found in this case that a debtor’s solvency was not relevant to an application of § 502(b)(6) and that there was no requirement in the Code that a debtor be insolvent affirming the bankruptcy court’s decision that it is not bad faith for debtors to file for bankruptcy in order to take advantage of a particular provision of the Code. PPI 228 B.R. 339, 345 (Bankr. Del. 1998), aff’d 324 F.3d 197 (3rd Cir. 2003). The bankruptcy court further held that the debtor was using section 502(b)(6) for exactly its intended purpose. PPI 228 B.R. at 345. The PPI court relied on a “totality of the circumstances” test and found that in evaluating a debtor’s good faith, the court’s only inquiry is to determine whether the debtor seeks to abuse the bankruptcy law by employing it for a purpose for which is was not intended. PPI 228 B.R. at 345.
In re Federated Department Stores, Inc., 131 B.R. 808, 813 (S.D. Ohio 1991), the court did not prohibit a debtor from filing chapter 11, instead finding that a “debtor’s duty to unsecured creditors who happen to be lessors does not include the performance of an otherwise useless act for the sole purpose of helping the lessor to avoid the statutory cap of § 502(b)(6).”
Cases discussing a solvent chapter 11 debtor’s good faith are not limited to instances where the debtor seeks to utilize § 502(b)(6).
The Ninth Circuit in Platinum Cap., Inc. v. Sylmar Plaza, L.P. (In re Sylmar Plaza, L.P.), 314 F.3d 1070, (9th Cir. 2002), cert. denied., 538 U.S. 1035; 155 L.Ed.2d 1065, 123 S. Ct. 2097 (2003) ruled in favor of a debtor and held it was not per se bad faith to file a bankruptcy plan solely to use the cure and reinstatement provisions of § 1124(2). The debtors owned a shopping center that was subject to a secured loan from the bank. The debtors ultimately defaulted on the loan. The debtor sold the center free and clear of the bank’s lien. The bank objected to the debtor’s plan which allowed the debtor to pay the bank’s claim at a regular interest rate and not a default rate. The Ninth Circuit found that insolvency is not a prerequisite to a finding of good faith and the fact that a creditor’s contractual rights are adversely affected does not by itself warrant a bad faith filing. Sylmar Plaza 314 F.3d at 1074-75.
A chapter 13 debtor may also take advantage of § 502 (b)(6). To illustrate the holdings of these preceding cases in a chapter 13 context, consider the following hypothetical. A chapter 13 debtor owns real estate which is not his primary residence. He is current on the mortgage obligation on the property and has no other debt (either secured or unsecured). The value of the property is less than the amount of the mortgage. The debtor files a chapter 13 for the sole purpose of bifurcating his mortgage obligation under § 506(a) into secured and unsecured portions with the intent of paying the secured portion and paying a percentage of the unsecured portion over the life of the chapter 13 plan. Would this filing be a good faith filing?
Under the holdings of PPI, Chameleon and Sylmar Plaza such a case would survive a good faith inquiry because the debtor was using the Code “for a purpose for which it was intended.” The Liberate and Integrated Telecom courts would reach a different result. Which result is correct? As stated previously, courts have held that solvency is not a prerequisite to filing either a chapter 11 or 13 petition. The Liberate and Integrated Telecom courts have become gatekeepers, preventing a certain class of debtors, namely those that are solvent, from filing petitions seeking to reorganize. These courts have determined that an entity must be insolvent before being allowed to reorganize under the Code. However, it is unclear what section of the Code these courts rely on to reach a determination that solvency is a barrier to a good faith filing and why they have abandoned a “totality of the circumstances” test. Clearly, they are not relying on section 109 which discusses a debtor’s eligibility.
Section 109 (d) states: Only a railroad, a person that may be a debtor under chapter 7 of this title (except a stockbroker or a commodity broker), and an uninsured State member bank, or a corporation organized under section 25A of the Federal Reserve Act, which operates, or operates as, a multilateral clearing organization pursuant to section 409 of the Federal Deposit Insurance Corporation Improvement Act of 1991 may be a debtor under Chapter 11 of this title.
Section 109(e) states: Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $307,675 and noncontingent, liquidated, secured debts of less than $922,975, or an individual with regular income and such individual’s spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $307,675 and noncontingent, liquidated, secured debts of less than $922,975 may be a debtor under chapter 13 of this title.
Solvency is conspicuously absent as a factor to determine a debtor’s eligibility under chapter 11 or 13. By requiring a debtor to be insolvent, the Liberate and Integrated Telecom courts are adding an additional requirement of eligibility which is not found in the Code.
If Congress had intended that solvency be a requirement for filing chapter 11 or chapter 13 it could have written it into sections 109(d) and (e). When discussing the eligibility requirements for a debtor under chapter 9, the Code states at § 109(c) in part that an entity may be a debtor under chapter 9 of this title if and only if such entity-…(3) is insolvent. Had Congress wanted similar requirements for chapter 11 and chapter 13 debtors, it could have inserted similar language.
Based upon a literal reading of the Code, if a debtor meets the eligibility requirements found in section 109, it should be able to attempt to propose a plan of reorganization. Courts should employ a “totality of the circumstances” test to each case to determine whether or not a particular debtor has filed its petition in bad faith, considering a debtor’s solvency as a factor, not the only factor. As stated earlier, Fredericks and Sagerman’s article which heralded a shift from the “totality of circumstances” may be premature. Further, the holdings in Liberate and Integrated ignore the plain language of § 109(d) and (e) which allow a solvent debtor to file a petition to reorganize. As the Supreme Court has held in U.S. v. Ron Pair Enterprises, 489 U.S. 235, 109 S. Ct. 1026, 103 L.Ed. 2d 290 (1989), when a statute is unambiguous on its face, it must be read literally.
The mere fact that a debtor is solvent should not cause a case to lack good faith “per se.” A debtor may file for the sole purpose of taking advantage of certain code sections such as 502(b)(6) or 506(a). To preclude a solvent debtor from filing for reorganization when they seek to take advantage of certain sections of the Code creates an additional requirement of eligibility. If Congress had intended that debtors seeking reorganization be insolvent, it could have drafted such language into section 109 (d) and (e), like it did in 109(c). In its present form, that language is not included in section 109 and this author believes that the courts seeking to add this additional eligibility requirement are thwarting Congressional intent by limiting chapter 11 or chapter 13 filings to insolvent debtors.
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