August 3, 2022

Combatting “Bad Faith” Bankruptcy Filings

By: James D. Silver, Partner

KK TAKEAWAY: A “bad faith” bankruptcy filing can be a powerful weapon in the hands of an unscrupulous debtor. However, mortgagees, landlords, as well as other creditors and parties-in-interest have a powerful weapon in their arsenal – a motion to dismiss or for stay relief based on the bankruptcy having been filed in bad faith.

BACKGROUND: Bankruptcy can help the honest but unfortunate debtor. However, there are unscrupulous debtors use the bankruptcy process in bad faith, which can occur in a myriad of ways. Other parties can get caught up in these unscrupulous bankruptcies when pursuing foreclosures, eviction proceedings, enforcement proceedings, and other litigation inappropriately delayed, or where the bankruptcy is used solely as a litigation tactic to get a leg up.

The Bankruptcy Code and case law interpreting it provides powerful tool in combatting “bad faith” bankruptcies. Where a bankruptcy has been filed in bad faith, a court may dismiss the bankruptcy, grant stay relief to permit the secured creditor to finalize its foreclosure or to permit creditors and other parties to conclude their litigation, or it may deny confirmation of a proposed bankruptcy plan.

It may also be argued that a bankruptcy court also has broad authority to provide relief where a debtor inappropriately files a suggestion of bankruptcy in non-bankruptcy court litigation involving a matter not stayed by the bankruptcy, for example, by using its inherent power to sanction the debtor or its bankruptcy attorney.

A voluntarily filed chapter 11 petition is subject to dismissal under 11 U.S.C.A. § 1112 if “not filed in good faith.” In re Phoenix Piccadilly, Ltd., 849 F.2d 1393, 1394 (11th Cir. 1988). This good faith requirement is rooted in equity and intended to prevent abuse of the Chapter 11 process. Matter of Little Creek Dev. Co., 779 F.2d 1068 (5th Cir. 1986). “A good faith standard protects the jurisdictional integrity of the bankruptcy courts by rendering their equitable weapons…available 14 | IN THE NOW “to delay or frustrate the legitimate efforts of secured creditors to enforce their rights.” See Phoenix Piccadilly, Ltd. V. Life Ins. Co. of Virginia (In re Phoenix Piccadilly, Ltd.), 849 F.2d 1393, 1394 (11th Cir. 1988) (affirming dismissal of chapter 11 case filed by owner of apartment complex that was subject to foreclosure action filed by secured creditors prior to bankruptcy filing). See also State St. Houses, Inc. v. New York State Urban Dev. Corp. (In re State St. Houses, Inc.), 356 F.3d 1345, 1346-47 (11th Cir. 2004) (same).

Courts have also recognized as indicia of bad faith, lack of financial distress of the debtor, few non-insider unsecured creditors, use of Chapter 11 to resolve pre-petition two-party disputes in state court and timing of a petition that evidences its primary use as a litigation tactic. See In re Serfass, 325 B.R. 901, 905–06 (Bankr. M.D. Fla. 2005), In re Moog, 159 B.R. 357, 361 (Bankr. S.D. Fla. 1993); In re Punta Gorda Associates, 143 B.R. 281, 283–84 (Bankr. M.D. Fla. 1992); In re On the Ocean, Inc., 16-16204-BKC-RBR, 2016 WL 8539791, at *2 (Bankr. S.D. Fla. June 6, 2016).

The courts do not generally condone the use of Chapter 11 to resolve two-party disputes in the bankruptcy court when such litigation is still pending in a non-bankruptcy forum prior to the commencement of the case. In re Serfass, 325 B.R. at 905–06. Chapter 11 was never intended to be used as a fist in a two-party bout. In re Moog, 159 B.R. at 362 citing In re HBA E., Inc., 87 B.R. 248, 260 (Bankr. E.D.N.Y. 1988). One court has found that a bankruptcy case should be dismissed when it “involves nothing more than a two-party dispute.” Matter of Indian Rocks Landscaping of Indian Rocks Beach, Inc., 77 B.R. 909, 911 (Bankr. M.D. Fla. 1987).

Filing a Chapter 11 petition merely to obtain a tactical litigation advantage is not within “the legitimate scope of the bankruptcy laws.” In only to those Debtors and creditors with ‘clean hands.’” Id. Bankruptcy courts may likewise dismiss bankruptcies filed under other chapters of the Bankruptcy Code where the bankruptcy process is being abused and the petition has been filed in bad faith. See, e.g., In re Alt, 305 F.3d 413, 418 (6th Cir. 2002) (bankruptcy court may dismiss Chapter 13 bankruptcy filed in bad faith); In re Buis, 337 B.R. 243, 250 (Bankr. N.D. Fla. 2006) (same); In re Piazza, 719 F.2d 1253 (11th Cir. 2013) (“[T]he power to dismiss ‘for cause’ in §707(a) includes the power to involuntarily dismiss a Chapter 7 case based on prepetition bad faith.”).

The filing of a bankruptcy in bad faith also constitutes “cause” pursuant to 11 U.S.C.A. § 362(d)(1) to terminate or lift the stay to permit a party to conclude litigation or the exercise of remedies in a non-bankruptcy court. In re Phoenix Piccadilly, Ltd., 849 F.2d 1393, 1394. The same standard of bad faith that is applied to determine whether a case should be dismissed under U.S.C. § 1112(b) may also be used to determine whether there is cause to lift the stay. Id. However, a finding that the factors are insufficient for purposes of dismissal does not mean that they are insufficient for purposes of stay relief. In re Dixie Broad., Inc., 871 F.2d 1023, 1029 (11th Cir. 1989). “If that were true, there would not be a need to ever lift a stay for bad faith, because the petition would necessarily have to be dismissed.” Id. Rather, a bankruptcy judge may take into consideration the number of factors and their certainty in determining whether they constitute bad faith for purposes of stay relief or dismissal. Id. Although there is no specific test for determining whether a debtor has filed a petition in bad faith, courts consider factors that evidence “intent to abuse the judicial process and the purposes of the reorganization provisions” or, in particular, factors that evidence that the petition was filed IN THE NOW | 15 relief should not be made available to an entity solely to get an upper hand in litigation against another party, nor solely to provide an alternate forum for a debtor. Matter of Nw. Place, Ltd., 73 B.R. 978, 982 (Bankr. N.D. Ga. 1987).

The timing of a Chapter 11 petition can evidence it was filed to obtain a tactical litigation advantage. For example, in In re Miracle Church of God in Christ, 119 B.R. 308, 310 (Bankr. M.D. Fla. 1990), re SGL Carbon Corp., 200 F.3d at 165. The Bankruptcy provisions are intended to benefit those in genuine financial distress, not to be used as a mechanism to orchestrate pending litigation. Id. Eviction cases are no exception to this rule. “Courts have routinely found bad faith and dismissed cases in circumstances where debtors have filed to purposely delay a creditor’s inevitable recovery of its property.” In re On the Ocean, Inc., 2016 WL 8539791, at *2. Chapter 11 16 | IN THE NOW terminated lease through a bad faith bankruptcy petition. Id. at 279. 11 U.S.C. §362(d)(4) “permits the bankruptcy court to grant so called ‘in rem’ relief from the automatic stay to the creditor to address schemes using bankruptcy to thwart legitimate foreclosure efforts foreclosure efforts through one or more transfer of interest in real property or … multiple bankruptcy filing affecting the subject in rem property.” Rodriguez v. Murphy, 2014 WL 1414424, ** 3-4 (S.D. Fla. Apr. 11, 2014). Unfortunately, “bad faith” bankruptcy filing can be a powerful weapon in the hands of an unscrupulous debtor. However, mortgagees, landlords, as well as other creditors and parties-in-interest have a powerful weapon in their arsenal – a motion to dismiss or for stay relief based on the bankruptcy having been filed in bad faith. the court inferred bad faith where Debtor’s bankruptcy petition was filed shortly before a scheduled foreclosure sale.

A bankruptcy filing may also be in “bad faith” where it is done for the purposes of second guessing the rulings of a state court. As recognized by one bankruptcy court, “debtors are not entitled to have the Bankruptcy Court hear their complaints merely because they are disgruntled with the process in State Court.” In re Muskogee Envtl. Conservation Co., 236 B.R. 57, 66–67 (Bankr. N.D. Okla. 1999).

Courts have also found bad faith where debtors filed bankruptcy petitions solely to delay a landlord’s recovery of real property. In re Premier Auto. Services, Inc., 492 F.3d 274 (4th Cir. 2007). For example, in In re Premier Automotive Services, Inc., the court was particularly offended by the debtor’s attempt to “resuscitate” a validly terminated lease through a bad faith bankruptcy petition. Id. at 279.

11 U.S.C. §362(d)(4) “permits the bankruptcy court to grant so called ‘in rem’ relief from the automatic stay to the creditor to address schemes using bankruptcy to thwart legitimate foreclosure efforts foreclosure efforts through one or more transfer of interest in real property or … multiple bankruptcy filing affecting the subject in rem property.” Rodriguez v. Murphy, 2014 WL 1414424, ** 3-4 (S.D. Fla. Apr. 11, 2014).

Unfortunately, “bad faith” bankruptcy filing can be a powerful weapon in the hands of an unscrupulous debtor. However, mortgagees, landlords, as well as other creditors and parties-in-interest have a powerful weapon in their arsenal – a motion to dismiss or for stay relief based on the bankruptcy having been filed in bad faith.

James D. Silver is an “AV” rated Partner and the Head of the firm’s Commercial Creditors Rights Bankruptcy Practice Group at Kelley Kronenberg. James focuses his practice on business bankruptcies, receiverships, the enforcement of creditors’ rights, and complex commercial litigation.

Contact James Silver at:
Phone: (954) 370-9970
Email: jsilver@kklaw.com

DISCLAIMER: This article is provided as a courtesy and is intended for the general information of the matters discussed above and should not be relied upon as legal advice. Neither Kelley Kronenberg, nor its individual attorneys or staff, are responsible for errors, omissions and/or typographical errors – always seek competent legal counsel.