Luxurious Lifestyles Can Undermine the Good Faith Requirement for 
Proposed Chapter 11 Plans of Reorganization

By: Spencer Nelson

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff Member

Luxurious lifestyles alone do not violate the good faith requirement for proposing a plan of reorganization under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”).  In In re Hamilton-Gaertner, a North Carolina Bankruptcy Court found that the debtor’s proposed Chapter 11 plan satisfied the good faith requirement of section 1129(a)(3) of the Bankruptcy Code, despite certain expenses typically indicative of bad faith.[1] The debtor was a physician who earned approximately $400,000 per year.[2] A married mother of three, her expenses included: private school tuition for her children; two vacation timeshare mortgages; a mortgage on her primary residence; and liens on multiple vehicles.[3] Facing financial distress, the debtor filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code.[4] Debtor’s initial proposed plan was rejected by the judgment creditors because it paid them less than twenty percent on the outstanding debts. The second plan proposed paying those creditors in full over two decades. Although the creditors voted to accept the second proposed plan, the bankruptcy court refused to confirm the plan because it concluded that the plan was not feasible and it unfairly discriminated against other creditors. The third plan called for a seventy percent distribution to the judgment creditors over nine years, amounting to approximately  $96,000.00 per year.[5] One creditor objected to confirmation of the plan for a number of reasons, inter alia, the plan did not satisfy the good faith requirement of section 1129(a)(3). According to the objecting creditor, the plan would allow the debtor to continue to paying certain extravagant expenses and otherwise continue her enjoyment of an above average lifestyle.[6] The court held that the plan was proposed in good faith under the totality of the circumstances.[7] It noted that the debt owed to the objecting creditor was business-related, and not due to the debtor’s personal or familial expenses.[8] With regard to the debtor’s insistence on private schools for her children, the court noted that it, “might agree with [the objecting creditor] if the Debtor were not proposing a distribution to unsecured creditors substantially higher than required.”[9] The court accepted the debtor’s explanation on why her expenses were not extravagant under the circumstances, and the court held that such expenses did not vitiate the Bankruptcy Code’s good faith requirement.[10] The court also chided the debtor for maintaining the “Disney timeshare mortgages” but still concluded that the plan was proposed in good faith “when considering the totality of what is being provided to creditors under this plan.”[11] The plan was ultimately confirmed by the court.[12]

The purpose of the Bankruptcy Code is to provide honest debtors with a fresh start.[13] To protect this purpose, the Bankruptcy Code requires good faith on the debtor’s part both in filing a bankruptcy petition and in proposing a reorganization plan.[14] Good faith is defined by common law.[15] Thus, there are multiple standards for good faith inquires, depending on the jurisdiction and the phase of the bankruptcy proceeding.[16] The good faith standard used in In re Hamilton-Gaertner for the confirmation of a Chapter 11 plan under section 1129(a)(3) is typical: whether, under the totality of the circumstances, “there is a reasonable likelihood that the plan will achieve a result consistent with the objectives and purposes of the Bankruptcy Code.”[17] This standard encompasses many realms including attempts to abuse the Code by using it for improper purposes, failure to actually or adequately reorganize, ability to pay, and underpayment of creditors.[18] Because the good faith requirement is determined by the facts and circumstances in each case, a comparative analysis is helpful. In re Osborne is a potent contrast to In re Hamilton-Gaertner. Decided by the same court, the two cases yield different results for wealthy debtors with extravagant expenses and luxurious lifestyles proposed in their Chapter 11 plans. In In re Osborne, the debtors’ proposed plan retained a Lexus automobile, a vacation home, and a $140,000.00 “rainy day fund.”[19] The year prior to filing, the husband-debtor earned $314,000.00.[20] The debtors had “over $500,000 in unsecured debt, [but] . . . only propose[d] to pay $20,000 to the unsecured class.”[21] The court fumed over the proposed distribution as compared to the debtors’ substantial assets, found that the plan was not proposed in good faith, and described the proposed distribution as “tossing the unsecured creditors a bit of spare change.”[22] The plan was not confirmed.[23] The court distinguished In re Hamilton-Gaertner from In re Osborne on the basis of the debtor’s proposed distribution to creditors.[24]

The conclusion to be drawn is simple, if a debtor wishes to continue an extravagant lifestyle during or after bankruptcy, the debtor should propose to substantially repay its creditors. Bankruptcy courts will likely find that a plan that fails to pay creditors a substantial portion of their claim yet allows the debtor to maintain an extravagant lifestyle was proposed in bad faith.[25]

[1] In re Hamilton-Gaertner, No. 17-00271-5-DMW, 2019 Bankr. LEXIS 1401, at *18–19 (Bankr. E.D.N.C. May 1, 2019).

[2] Id. at *2, *9.

[3] Id. at *2, *16–18.

[4] Id. at *3.

[5] Id. at *6, *8, *17.

[6] Id. at *11–12.

[7] Id. at *19.

[8] Id. at *15–16 (“While the issue is not before the court, it believes that the Debtor has viable arguments that her debts are not primarily consumer in nature.”).

[9] Id. at *6.

[10] Id. at *17 (“The Debtor explained convincingly why reducing some of her expenses deemed extravagant by Ascentium was neither practical nor desirable.”).

[11] Id. at *7.

[12] Id. at *28.

[13] See Giaimo v. DeTrano (In re DeTrano), 326 F.3d 319, 322 (2d Cir. 2003).

[14] See Carolin Corp. v. Miller, 886 F.2d 693, 699–702 (4th Cir. 1989); The good faith requirement to confirm a plan is explicit, however the good faith requirement when petitioning the court has been implied by case law. See 11 U.S.C. § 1129(a)(3) (2012) (“The 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.”); Ali M.M. Mojdehi & Janet Dean Gertz, The Implicit "Good Faith" Requirement in Chapter 11 Liquidations: A Rule in Search of A Rationale?, 14 Am. Bankr. Inst. L. Rev. 143, 148–52 (2006) (discussing good faith in petitioning the bankruptcy court).

[15] See In re Madison Hotel Assocs., 749 F.2d 410, 424–25 (7th Cir. 1984).

[16] See id.; Carolin Corp., 886 F.2d at 699–702 (“Some courts require that both objective futility and subjective bad faith be evident . . . . Other courts apparently hold that threshold dismissal may be warranted when either futility or bad faith is then evident.”).

[17] In re Hamilton-Gaertner, 2019 Bankr. LEXIS 1401, at *11; see In re Osborne, No. 12-00230-8-SWH, 2013 WL 2385136, at *5 (Bankr. E.D.N.C. May 30, 2013) (reviewing cases); 7 Collier on Bankruptcy ¶ 1129.02 (Richard Levin & Henry J. Sommer eds., 16th ed. 2019) (“In re Madison Hotel Associates contains one of the earliest and best statements regarding the requirements of section 1129(a)(3).”).

[18] See, e.g., In re Osborne, 2013 WL 2385136 at, *5; In re Maxim Indus., Inc., 22 B.R. 611, 613 (Bankr. D. Mass. 1982) (“Bankruptcy is perceived as a haven for wistfulness and the optimist's valhalla where the atmosphere is conducive to fantasy and miraculous dreams of the phoenix rising from the ruins. Unfortunately, this Court is not held during the full moon, and while the rays of sunshine sometimes bring the warming rays of the sun, they more often also bring the bright light that makes transparent and evaporates the elaborate financial fantasies constructed of nothing more than the gossamer wings and of sophisticated tax legerdemain. I find that this plan which has a shell debtor purchasing a solvent corporation is such a gossamer wing and has not been proposed in good faith. Confirmation is denied pursuant to 11 U.S.C. § [] 1129(a)(1) and (3).”); In re Powers, 135 B.R. 980, 991 (Bankr. C.D. Cal. 1991) (reviewing definitions of good faith and indicia of bad faith); In re Egan, 142 B.R. 730, 734 (Bankr. E.D. Pa. 1992) ("We do not believe that a zero-payment plan as to unsecured creditors is inherently objectionable if the Debtors lack the means to make payments to such creditors."); In re Cheatham, 78 B.R. 104, 111 (Bankr. E.D.N.C. 1987) (“The court has considered the debtors' failure to timely comply with several court orders, but after considering the payments already made . . . and the terms of the plan proposed, the court finds that the plan was proposed in good faith.”).

[19] In re Osborne, 2013 WL 2385136, at *2–3.

[20] Id.

[21] Id. at *5.

[22] Id.

[23] Id. at *10.

[24] See In re Hamilton-Gaertner, 2019 Bankr. LEXIS 1401, at *5.

[25] See id. at *6 (“If a high income debtor's plan provides for the use of such income ‘to make heavy mortgage payments on a lavish house, to pay for luxury cars, and to generally support an extravagant lifestyle, the plan may not meet the confirmation requirements of 11 U.S.C. § 1129(a).’”) (quoting In re Fernandez, 97 B.R. 262, 263 (Bankr. E.D.N.C. 1989)).