NRA Bankruptcy Case Dismissal is a Stark Reminder of Good-Faith Filing Requirement in Chapter 11
Chapter 11 bankruptcy offers corporate debtors many benefits, including the automatic stay, discharge of debts, rejection of unfavorable contracts and promise of a fresh start. However, along with these and other benefits come corresponding responsibilities, such as the requirement to file and prosecute a Chapter 11 case in good faith.
The good-faith requirement is intended to prevent abuse of Chapter 11 bankruptcy by those seeking to use it for reasons other than its primary purpose: to enable debtors to restructure debts and obtain a fresh start despite debt problems while treating creditors fairly.
If a debtor does not file in good faith, a bankruptcy judge can—as the National Rifle Association recently learned—dismiss the case.
The NRA Case
In August 2020, the New York Attorney General (“NYAG”) filed a complaint seeking dissolution of the National Rifle Association. The NRA subsequently filed a Chapter 11 case on January 15, 2021. Several parties in interest filed motions seeking dismissal of the NRA’s case for cause under section 1112(b) of the Bankruptcy Code or the appointment of a chapter 11 trustee or an examiner.
In its opinion dismissing the NRA’s case, the court concluded, “the question the Court is faced with is whether the existential threat facing the NRA is the type of threat that the Bankruptcy Code is meant to protect against. The Court believes it is not.” In re: National Rifle Association of America and Sea Girt LLC, Case No. 21-30085, D.I. 740 (Bankr. N.D.Tex. May 11, 2021).
The court found that, instead of using the bankruptcy courts for their intended purposes, the NRA filed bankruptcy to avoid dissolution. The court’s statement calls attention to the fundamental fact that the bankruptcy court is the proper forum for specific circumstances and should not be used as an instrument to evade claims and judgements in regulatory actions. The court’s conclusion shows the way the good faith requirement is used by the courts as a means to uphold the purpose of the bankruptcy process.
The Good Faith Requirement
While bankruptcy cases are typically easy to file, they do not always stick. In some instances, questions arise about what motivated a filing which may result in a court dismissing a debtor’s case entirely. Under section 1112(b) of the Bankruptcy Code, the court may dismiss a bankruptcy case “for cause.”
Although section 1112(b) does not explicitly require that cases must be filed in "good faith", courts have overwhelmingly held that a lack of good faith in filing a Chapter 11 petition constitutes cause for dismissal. Marsch v. Marsch (In re Marsch), 36 F.3d 825, 828 (9th Cir. 1994). “Good faith is a predicate to the right to file a petition in bankruptcy, as only the ‘honest but unfortunate debtor’ is eligible to avail itself of the protections afforded by the Bankruptcy Code.”In re Jer Jameson Mezz Borrower II, LLC, 461 B.R. 293, 297 (Bankr. D. Del. 2011).
The “honest but unfortunate debtor” categorization casts a wide net, and therefore results in only a small number of cases being dismissed for lack of good faith. However, in some situations, such as the NRA case, courts are faced with questions about what constitutes good faith and how to detect when bad faith is present in filing for bankruptcy. Therefore, a discussion of good faith analyses is necessary to understand filing requirements and dismissals in the bankruptcy courts.
The Bankruptcy Code does not uniformly define “good faith.” Accordingly, the standard is applied to determine good faith varies across jurisdictions. The bankruptcy court in the NRA case, citing the U.S. Court of Appeals for the Fifth Circuit Court, explained that “determining whether the debtor's filing for relief is in good faith depends largely upon the bankruptcy court's on-the-spot evaluation of the debtor's financial condition, motives, and the local financial realities.”
Neither the U.S. Supreme Court nor the Sixth Circuit Court of Appeals have adopted a precise definition of good faith, however both acknowledge that an analysis requires a factual inquiry and the weighing of a range of factors.
Courts also differ in the standards they use for evaluating good faith and on whom they place the burden of establishing good faith. Some courts require the debtor to establish good faith whereas others may require a prima facie case for lack of good faith before the burden shifts to the debtor. For example, in the Third Circuit, the burden is on the bankruptcy filer to establish good faith. In contrast, the Fifth Circuit requires the party moving for dismissal to make a “prima facie showing of a lack of good faith,” after which the burden shifts to the debtor to demonstrate such faith.
Despite a lack of uniformity regarding the standards for evaluating good faith under section 1112(b), most courts have used similar, if not identical, factors in their analyses. This is done because the underlying function of the good faith requirement, which is echoed in the court’s opinion in the NRA case, is to ensure the bankruptcy court is being used for its intended purpose. The Sixth Circuit has articulated eight factors that may be "meaningful in evaluating" whether a filing was done in bad faith, including:
1. the debtor has only one asset;
2. improper pre-petition conduct;
3. few unsecured creditors;
4. the debtor has been unsuccessful in defending against the foreclosure of its property in state court;
5. the debtor and one creditor have proceeded to a standstill in state court litigation, and the debtor has lost or has been required to post a bond which it cannot afford;
6. the filing of the petition effectively allows the debtor to evade court orders;
7. the debtor has no ongoing business or employees; and
8. a lack of possibility of reorganization.
In the NRA case, as well as others, the sixth factor weighed heavily in the court’s dismissal of the case. In short, courts seek to determine whether debtors file bankruptcy merely as a method of forum shopping. For example, in the NRA case, the court concurred with the NYAG’s assessment that “the NRA is using this bankruptcy case to address a regulatory enforcement problem, not a financial one.” The court determined that the NRA shopped for the forum that would serve to protect its interests against the NYAG and had not selected the bankruptcy court for its intended purpose of allowing an entity to remain financially viable in the face of ongoing litigation.
Implications of the NRA Case and Good-Faith Filing Requirement
Despite the fact that the “good faith” requirement of section 1112(b) is not concretely defined in the Bankruptcy Code, and courts have not agreed upon a uniform standard to evaluate the requirement, standards have emerged that should inform would-be debtors’ decisions as to whether a filing would be in good faith or not. The NRA case, as well as other other modern cases, illustrate courts’ intentions to preserve the intended purpose of Chapter 11 bankruptcy, deter avoidance or evasion from enforcement actions, and identify instances of forum shopping by enforcing a good-faith filing requirement.
Accordingly, the NRA case underscores the importance of clearly outlining proper purposes for any bankruptcy filing and following corporate governance requirements when making the decision to file for bankruptcy.