A Court May Dismiss a Bankruptcy Case Filed in Bad Faith

By: Antonio G. Sciarrotta

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

            In In re The Sunshine Group, LLC., the United States Bankruptcy Appellate Panel of the Ninth Circuit affirmed the dismissal of a bankruptcy case because it was filed in bad faith.[1] The Sunshine Group, LLC. (the “Debtor”) operated a motel until 2015, when it began to develop plans to demolish the property and build an upgraded motel.[2] However, in 2016, the City of Dana Point alerted Debtor to several municipal violations.[3] Upon the city’s request, a receiver was appointed to take control of the property and correct the violations.[4] The receiver began the remediation process, acquiring money in a receiver’s certificate to secure the property and do the requisite work.[5] However, after further evaluation, the receiver determined that additional funding was necessary to complete the repairs.[6] Despite the Debtor’s objections and motion to terminate the receivership, the state court determined that the receiver’s plan was reasonable and authorized the funding.[7] However, before the receiver obtained the money to implement its plan, the Debtor filed a voluntary petition for relief under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”) with the United States Bankruptcy Court for the Central District of California.[8] Upon the requests of the city and the receiver, the bankruptcy court dismissed the case, finding that the debtor filed the petition in bad faith as a litigation tactic to avoid paying for the court approved remediation plan.[9]

            Section 1112(b) of the Bankruptcy Code allows a court to dismiss a case for cause when it is in the best interest of the creditors and the estate.[10] A bad faith filing of a bankruptcy petition is cause for dismissal.[11] However, section 1112(b) does not define bad faith.[12] Instead, a court will generally examine the facts to determine whether the debtor is trying to unreasonably deter and harass creditors or if he is attempting to effect a speedy, efficient recovery on a feasible basis.[13] Further, bad faith is not determined by one specific factor, but by a combination of factors that are given weight on a case by case basis.[14] If a debtor is attempting to achieve a goal outside the scope of bankruptcy, or it is an apparent two-party dispute that can be resolved outside the bankruptcy court, then the filing is likely in bad faith.[15] The Ninth Circuit Appellate Panel found that the Debtor in this case filed its petition in bad faith because the receivership challenge was a two-party dispute where a state court would have to determine the receiver’s actions were unnecessary, because the bankruptcy court lacked jurisdiction over this issue.[16] The court determined the filing was a mere litigation tactic to avoid the state court’s rulings.[17] Moreover, the Bankruptcy Appellate Panel cited factors from St. Paul Storage Ltd. P’ship v. Port Authority, such as the debtor having no revenues to fund a reorganization, the nonexistence of an ongoing business, and only possessing one asset, to support dismissal of the petition as a bad faith filing.[18]

            In its decision, the Ninth Circuit Appellate Panel acknowledged that a bankruptcy filing in the face of a receivership is not necessarily indicia of a bad faith filing.[19] However, this determination cannot be the case where the debtor is only trying to preclude further encumbrances on its assets.[20] The court also considered the argument that would allow the sale of the debtor’s property to fund reorganization under section 363 of the Bankruptcy Code.[21] The court rejected this assertion because possession of the property is lockstep with the plan of the receiver, which must be disposed of by the state court before the bankruptcy court may act on it.[22]