Bad Faith Constitutes Cause For Dismissal of a Bankruptcy Case

By: Kathleen Mullins

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

In In re Lee[1] the United States Bankruptcy Appellate Panel for the Sixth Circuit (the “BAP”) held that the bankruptcy court properly dismissed the debtor’s Chapter 11 bankruptcy petition because the debtor’s filing was abusive.[2] The debtor defaulted on her mortgage loan with Chase Home Finance (“Chase”) on one of her investment properties.[3] Chase sought to foreclose on the property, and the debtor filed bankruptcy, staying the foreclosure action.[4] This case was dismissed and Chase sought to foreclose a second time.[5] Once again, however, the debtor filed bankruptcy.[6] After the case was dismissed and Chase again attempted to foreclose, the debtor filed bankruptcy a third time.[7] This time Chase made a motion to dismiss the case, asserting that the debtor was acting in bad faith and was abusing the bankruptcy process in order to evade foreclosure by filing bankruptcy petitions whenever Chase made progress in the foreclosure action.[8] The bankruptcy court found that the debtor had been filing bankruptcy petitions “as a buffer to prevent the foreclosure proceedings from going forward” and it dismissed her case for acting in bad faith, which the court determined constituted sufficient “cause” under section 1112(b).[9]

Section 1112(b) states that “the court shall . . .dismiss a case under this chapter . . . for cause.”[10] Section 1112(b)(4) provides a non-exhaustive list of factors that constitute “cause” to dismiss a case, which does not explicitly include “bad faith.”[11] Nevertheless, the Sixth Circuit has previously determined that bad faith may constitute “cause” for dismissal under section 1112(b)(1) and the Sixth Circuit employs a “totality of the circumstances” test in order to determine when a debtor has acted in bad faith.[12] The BAP reviewed the debtor’s indicia of bad faith, including that: (i) the debtor was a “serial filer” of bankruptcy petitions, (ii) she failed to “aggressively or diligently” pursue her cases, (iii) she failed to comply with filing requirements, (iv) she failed to produce proper documents in regards to her cases and, (v) she failed to pay filing fees.[13] In light of all of these factors, the BAP upheld the bankruptcy court’s finding that the debtor had acted in bad faith and that her bad faith was “cause” for dismissal under section 1112(b).[14]

Although section 1112(b)(4) does not explicitly indicate that bad faith constitutes “cause” for dismissal under section 1112(b)(1), all of the circuits recognize that bad faith is grounds for dismissal of a bankruptcy petition.[15] However, while all of the circuits agree that bad faith constitutes “cause” for dismissal, each circuit determines bad faith differently. In particular, there is a marked split of authority between the Fourth Circuit’s subjective bad faith plus objective futility test[16] and the Eleventh Circuit’s approach, which does not inquire into whether a debtor has any realistic means of successfully reorganizing.[17] The BAP in In re Lee used the “totality of the circumstances” test that appears similar to the Fourth Circuit’s test, which included an examination of the debtor’s prospects for future income. However, the BAP did not explicitly inquire into whether the debtor’s petition was objectively futile. Therefore, it is yet to be seen whether the Sixth Circuit will look for objective futility in future cases when deciding if bad faith is grounds for dismissal of a bankruptcy petition.

 

 

[1] In re Lee, 467 B.R. 906 (6th Cir. BAP 2012).
[2] Id. at 918 (“The bankruptcy court clearly did not abuse its discretion in granting Appellee’s Motion to Dismiss Debtor’s bankruptcy case for cause pursuant to 11 U.S.C. § 1112(b).”).
[3] Id. at 912.
[4] Id.
[5] Id.
[6] Id. The debtor had first filed a Chapter 13 petition on October 20, 2009, which was dismissed for failure to file a plan or schedule. She then filed a pro se petition under Chapter 7 two months later which was also dismissed for failure to produce proper documentation at her § 341 meeting of creditors. Finally, she filed a pro se petition under Chapter 11 on April 5, 2011, which is the subject of this lawsuit. Id. at 912-13.
[7] Id.
[8] Id. at 913.
[9] Id. at 913-14, 917.
[10] 11 U.S.C. § 1112(b)(1) (emphasis added).
[11] 11 U.S.C. § 1112(b)(4) (2006); see also In re Lee, 467 B.R. at 917 (“Section 1112(b)(4) contains a non-exhaustive list of examples of “cause” justifying dismissal of a chapter 11 case.”).
[12] See In re Lee 467 B.R. at 917 (“It is well settled in the Sixth Circuit that a debtor’s bad faith in filing a chapter 11 may serve as cause for dismissal under § 1112(b)(1); see also Alt v. United States (In re Alt), 305 F.3d 413, 419 (6th Cir. 2002) (“Our circuit’s good faith test requires consideration of the totality of the circumstances.”) (citing Society Nat’l Bank v. Barrett (In re Barrett), 964 F.2d 588, 591 (6th Cir. 1992)); Mich. Nat’l Bank v. Charfoos (In re Charfoos), 979 F.2d 390, 392 (6th Cir. 1992) (“It is well settled that even though Chapter 11 does not expressly so state, bad faith may serve as a ground for dismissal of a petition.”); Trident Assocs. Ltd. P’ship v. Metro. Life Ins. Co. (In re Trident Assocs. Ltd. P’ship), 52 F.3d 127, 130 (6th Cir. 1995)(“We have consistently held that a debtor’s chapter 11 petition may be dismissed if it was filed in bad faith.”).
[13] In re Lee, 467 B.R. at 918.
[14] Id.
[15] See C-TC 9th Ave. P’ship. v. Norton Co., 113 F.3d 1304, 1310 (2d Cir. 1997) (stating that implicit good faith standard is required for bankruptcy petitions because it “furthers the balancing process between the interests of debtors and creditors.”); Carolin Corp. v. Miller, 886 F.2d 693, 699 (4th Cir. 1989) (“a generalized good faith requirement appears implicit in § 1112(b).”); Phoenix Picadilly Ltd. v. Life Ins. Co., 849 F.2d 1393, 1394 (11th Cir. 1988) (“A case under Chapter 11 may be dismissed for cause pursuant to section 1112 of the Bankruptcy Code if the petition was not filed in good faith.”); see also In re SGL Carbon Corp., 200 F.3d 154, 160 (3d Cir. 1999); Marsch v. Marsch 36 F.3d 825, 828 (9th Cir. 1994); In re Winslow, 123 B.R. 641, 646-47 (10th Cir. 1991); First Nat’l Bank of Sioux City v. Kerr (In re Kerr), 908 F.2d 400, 404 (8th Cir. 1990); Little Creek Dev. Co. v. Commonwealth Mortgage, 779 F.2d 1068, 1072 (5th Cir. 1986); In re Madison Hotel Assocs., 749 F.2d 410, 426 (7th Cir. 1984); Connell v. Coastal Cable TV, 709 F.2d 762, 765 (1st Cir. 1983).
[16] See Carolin Corp v. Miller, 886 F.2d at 701 (explaining concept of objective futility).
[17] See Phoenix Picadilly Ltd. v. Life Ins. Co., 849 F.2d at 1394. 
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Bankruptcy Litigation
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