The Objective and Jurisdictional Origins of Chapter 11's Good Faith Filing Requirement.

• Author: Fruchter, Steven

INTRODUCTION

Although the Bankruptcy Code does not expressly require a chapter 11 petition to be filed in good faith, there is a judicial consensus that Chapter 11 cases are subject to dismissal under 11 U.S.C. [section] 1112(b) if the petition was not filed in good faith. Courts, however, employ different approaches in determining whether a filing was in good faith. Some courts focus on whether the petitioner filed for Chapter 11 relief with subjective bad faith motivations. Other courts disregard the petitioner's subjective motivations entirely and will find that a case was not filed in good faith only if it was clear at the time of filing that the debtor had no reasonable prospect of reorganizing. Still other courts consider the totality of the circumstances--both the debtor's objective circumstances and subjective motivations in filing.

As a result of the disparate factors courts weigh in making the good faith filing determination, in certain circumstances, it can be difficult to predict whether, or on what basis, a bankruptcy court will dismiss a Chapter 11 case for having not been filed in good faith. This article contends that if bankruptcy courts were to apply the objective and jurisdictional framework for identifying abusive filings that courts employed under the Bankruptcy Act of 1898, good faith filing decision-making under Chapter 11 would be more consistent. This predictability would result in less frequent litigation at early stages of the Chapter 11 process and preserve judicial resources.

Part I of this article traces the development of the good faith filing requirement from the New Deal era amendments to the Bankruptcy Act of the early 1930s to the enactment of the modern Bankruptcy Code in 1978. Part II contrasts the jurisdictional requirements for filing a corporate reorganization bankruptcy proceeding under the Bankruptcy Act with the requirements set forth in Chapter 11 of the modern Bankruptcy Code. Part III provides an overview of the Chapter 11 good faith filing requirement that is currently applied by courts and considers two recent cases in which the Chapter 11 petition was dismissed for not having been brought in good faith. Finally, Part IV explains how courts can and should apply an objective and jurisdictional good faith filing framework to cases brought under Chapter 11.

1. ORIGINS OF THE GOOD FAITH FILING REQUIREMENT

   Before the enactment of [section] 77B of the Bankruptcy Act in 1934 there was no federal bankruptcy statute providing for the reorganization of corporate debtors. (1) As a result, corporations in dire financial straits generally had three options: (1) liquidate, (2) consensually restructure debts with creditors, or (3) enter into an equity receivership proceeding--a judge-invented non-bankruptcy process that allowed a corporation to reorganize debts and continue to exist as a going concern. (2)

   In response to the Great Depression, the issues caused by the lack of a federal restructuring regime, and the perceived flaws of equity receiverships, Congress added three new reorganization sections to the Bankruptcy Act in 1933 and one new reorganization section to the Bankruptcy Act in 1934Congress intended each new section to be used by a specific category of debtor and for a specific purpose. Section 74 was "intended to secure relief to [individual] persons who, engaged in any business," by giving them "the opportunity to submit terms of compromise" with their unsecured creditors. (3) Section 75 was the statutory regime for compositions between farmers and unsecured creditors. (4) Section 77 was the statutory regime for railroad reorganizations. (5) Section 77B was the statutory regime for non-railroad corporate reorganizations. (6)

   1. GOOD FAITH UNDER [SECTION][SECTION] 74, 75, 77, AND 77B OF THE BANKRUPTCY ACT

      Of the four sections of the Bankruptcy Act enacted in the early 1930s, three imposed an express good faith "requirement for both filing and confirmation" ([section][section] 74, 77, and 77B) and only one ([section] 75) expressly required a finding of good faith "in connection with confirmation." (7) Under all four sections, a court's duty to determine that the debtor had filed their "petition in good faith" was satisfied by ensuring that the Bankruptcy Act's privileges "extended only to those who [were] within the contemplation of the act." (8)

      If a bankruptcy petition was filed by or on behalf of a party that did not qualify for relief under [section][section] 74 (9), 75 (10), 77 (11) or 77B (12), courts would protect their jurisdictional integrity by dismissing the petition for having not been filed in good faith. (13) Courts would also dismiss cases for not having been filed in good faith if the petitioner manufactured jurisdiction by changing its legal status (e.g., to a corporation, farmer, or creditor) in order to qualify as an eligible petitioner under a specific section of the Bankruptcy Act. (14)

      Under the railroad and corporate reorganization statutes ([section][section] 77 and 77B), courts would dismiss a case for not having been filed in good faith if liquidation, rather than reorganization, was the inevitable outcome of the proceeding. (15) In contrast, [section] 75 of the Bankruptcy Act expressly allowed for a debtor's orderly liquidation if a compromise with creditors could not be reached. (16) Courts would therefore not impute a 'lack of good faith to a farmer-debtor" for having filed a [section] 75 petition, even if it was clear from the outset of the case that the farmer would not be able to successfully reorganize. (17)

      In sum, under the four sections of the Bankruptcy Act enacted in the early 1930s, the good faith inquiry was objective and jurisdictional: if the correct kind of debtor filed a petition, and a bankruptcy proceeding could accomplish the purposes of the section of the Bankruptcy Act the petitioner was seeking to invoke, then so long as jurisdiction had not been artificially manufactured by the petitioner right before filing, the petition was filed in good faith.

   2. THE GOOD FAITH FILING REQUIREMENT OF CHAPTERS X AND XI UNDER THE BANKRUPTCY ACT

      In 1938 Congress repealed and replaced [section] 77B of the Bankruptcy Act with two new corporate reorganization chapters--Chapters X and XI. (18) Chapter X explicitly provided for dismissal of a petition if it had "not been brought in 'good faith,'" (19) and listed four non-exclusive circumstances in which a Chapter X filing would not have been brought in good faith: "if (1) the petitioning creditors ha[d] acquired their claims for the purpose of filing the petition; or (2) adequate relief would [have been] obtainable by a debtor's petition under the provisions of chapter 11 ...; or (3) it [would be] unreasonable to expect that a plan of reorganization c[ould] be effected; or (4) a prior proceeding [was] pending in any court and it appealed] that the interests of creditors and stockholders would be best subserved in such prior proceeding." (20) Under Chapter X, there was a judicial consensus that the meaning of the term "good faith," was not limited to the four negative objective indicia of bad faith that were statutorily enumerated thereunder. (21)

      Congress intended Chapter X to be used for "the reorganization of corporations with complicated debt structures and many stockholders" (22) and Chapter XI to be used by smaller debtors seeking to reorganize unsecured debts. (23) Because Chapter X and Chapter XI were "not alternate routes" of restructuring from which a debtor could choose, but rather "legally, mutually exclusive paths to attempted financial rehabilitation," (24) one of the four enumerated causes for dismissing a Chapter X petition, for having not been filed in good faith, was if "adequate relief would be obtainable ... under the provisions of chapter XI." (25)

      Chapter XI, as originally enacted, contained no express good faith petition filing requirement. (26) In SEC v. United States Realty and Improvement Company, the Supreme Court, relying on principles of equity, found that a court had the power to dismiss a Chapter XI petition to remit the debtor to more appropriate relief under Chapter X. (27) Moreover, in 1952, Congress amended Chapter XI to provide that upon a finding "that the proceedings should have been brought under chapter X of this Act," the judge could "enter an order dismissing the proceedings under [Chapter XI], unless the debtor amend[ed] its petition to seek Chapter X relief." (28)

      Like their statutory predecessor, both Chapter X and XI were "designed as vehicles for possible financial rehabilitation" and were not intended to be used for liquidation. (29) Accordingly, as was the case under [section] 77B, a petition was not brought in good faith under either chapter if it was clear from the outset that liquidation rather than restructuring of the company's debts would be the ultimate result of a bankruptcy proceeding. (30)

   3. SUBJECTIVE MOTIVATIONS AND GOOD FAITH UNDER THE BANKRUPTCY ACT

      Under the Bankruptcy Act, a petitioner's subjective motivations in filing were of secondary importance to the good faith filing inquiry. (31) Subjective motivations were used as a proxy for determining whether the petitioner was eligible to file for relief under the provision of the Bankruptcy Act they were seeking to invoke (32) and for determining whether the debtor had a reasonable possibility of successfully reorganizing. (33)

      If, for example, an individual formed a corporation to obtain jurisdiction to qualify for relief under a corporate restructuring provision of the Bankruptcy Act, then the petition (even if nominally brought by a corporation rather than an individual) would be dismissed for not having been brought in good faith. (34) In such a case, the court would often note in its opinion dismissing the proceeding that the petition had been filed with subjective bad faith motivations. (35) Nevertheless, the court's decision to dismiss the case for not...