In an important and recent decision, the Third Circuit dismissed a Chapter 11 petition when a financially healthy debtor lacked a valid re-organizational purpose. The debtor, therefore, surmised the Court, lacked the requisite "good faith" to file a Chapter 11 petition.
Nature of Case
In this case, the Third Circuit was called upon to interpret 11 U.S.C. ' 1112(b). 11 U.S.C. ' 1112(b) addresses, inter alia, when a petition may be dismissed for cause. The Third Circuit concluded that Section 1112(b) requires a debtor to file a Chapter 11 petition in good faith.
Factual Background
The United States Department of Justice investigated graphite electrode manufacturers for alleged price fixing. Among the manufacturers investigated was SGL Carbon. ("SGL" or "Debtor"), a Delaware corporation that manufactures and sells graphite electrodes for steel production. The investigation led other various steel producers to file class action antitrust lawsuits against SGL (the "Plaintiffs").
In response to the antitrust litigation, SGL filed a voluntary Chapter 11 petition in the United States District Court for Delaware.
SGL explained in a press release that it had filed for bankruptcy to protect itself against excessive demands made by plaintiffs in civil antitrust litigation. "[SGL] is financially healthy," said SGL's president. "If we did not face [antitrust] claims for such excessive amounts, we would not have had to file for Chapter 11. We expect to continue our normal business operations", he continued.
The chairman of SGL's parent company said that in fact, SGL is now "financially healthier" than before filing the petition. SGL's filing was "fairly innovative and creative" he added, "because usually Chapter 11 is used as protection against serious insolvency or credit problems." This, he said is "not the case" with SGL.
The Unsecured Creditor's Committee (the "Committee") filed a motion to dismiss SGL's petition since the Committee felt that the petition had not been filed in good faith. SGL, they contended, filed the petition as a litigation tactic aimed at frustrating the plaintiffs' antitrust claims.
The District Court
The District Court denied the Committee's motion to dismiss because:
- the distraction caused by the antitrust litigation posed a serious threat to SGL's continued operations; and
- should the Plaintiffs be successful in obtaining a judgment against SGL, SGL might be financially ruined.
The District Court assumed that 11 U.S.C. ' 1112(b) requires a debtor to file a Chapter 11 petition in good faith. The court did not decide the issue. The Committee appealed the court's decision to the Third Circuit.
The Issues Before The Third Circuit
The two issues presented before the Third Circuit were:
- Whether 11 U.S.C. ' 1112(b) requires a debtor to file a Chapter 11 petition in good faith; and
- Assuming a debtor is required to file in good faith, whether a debtor must have a valid re-organizational purpose in order for the debtor's filing to constitute a good faith filing.
Summary of The Third Circuit's Decision
The Third Circuit held that 11 U.S.C. ' 1112(b) requires a debtor to file a Chapter 11 petition in good faith. The Third Circuit further held that a financially healthy company filing a Chapter 11 petition merely to obtain a tactical litigation advantage lacked a valid re-organizational purpose. Conducting a fact intensive analysis, the court held that SGL was financially healthy and that the only reason it filed for bankruptcy was to gain a tactical litigation advantage against the Plaintiffs. Concluding that SGL did not file its petition in good faith the Third Circuit dismissed the petition.
In adopting a "good faith" standard, the Third Circuit grounded its decision on four factors:
- "the permissive language of Section 1112(b) viewed in light of its legislative history";
- decisions reached by other appellate courts;
- the equitable nature of bankruptcy; and
- the underlying purpose of Chapter 11.
Analysis
11 U.S.C. ' 1112(b) permits a court to dismiss or convert a Chapter 11 petition for cause. The Statute enumerates a list of ten non-exclusive cases where cause may exist. The statutory language however, does not require or prohibit imposing a "good faith" requirement on Chapter 11 petitioners. The legislative history states that the list "is not exhaustive". It adds that the court may consider other factors as they arise.
The Third Circuit pointed out that other appellate courts have held that a petition may be dismissed under 11 U.S.C. ' 1112(b) if it was filed in bad faith. Furthermore, the Third Circuit observed, other appellate courts have held that there is a general "good faith" requirement in Chapter 11 cases under which a petition may be dismissed for lack of "good faith".
In finding that the "good faith" requirement for Chapter 11 petitions has strong roots in equity, the Third Circuit explained that the goals and policies of bankruptcy law, as they pertain to a Chapter 11 re-organization, are "avoidance of the consequences of economic dismemberment and liquidation, and the preservation of ongoing values in a manner which does equity and is fair to [the] right and interest of the parties affected." The Third Circuit concluded that a debtor who wishes to invoke the protection of the bankruptcy code must act with clean hands.
Finally, the Third Circuit articulated that the underlying purpose of Chapter 11 requires a debtor to file a Chapter 11 petition in good faith. The Third Circuit explained that the requirement of filing in good faith "prevents abuse of the bankruptcy process by debtors whose overriding motive is to delay creditors without benefiting them in any way."
Considering the permissive language of the Statute and the accompanying legislative history, the decisions of other appellate courts, the equitable nature of bankruptcy proceeding and the underlying purpose of Chapter 11, the Third Circuit concluded that a Chapter 11 petition may be dismissed for cause under 11 U.S.C. ' 1112(b) unless it is filed in good faith.
Finding that a petition must be filed in good faith, the Third Circuit held that "a Chapter 11 petition is not filed in good faith unless it serves a valid re-organizational purpose". The Third Circuit rejected the District Court's finding and held that there was no evidence to support the conclusion that distraction from the antitrust litigation posed a threat to the Debtor's continued operation. Furthermore, there was no evidence that a judgment obtained in the antitrust litigation would financially ruin the Debtor's business. The Third Circuit explained that a company that is faced with massive litigation may in good faith file a Chapter 11 petition. However, in SGL's case, where the debtor was financially healthy, it was premature to file for bankruptcy. Thus, the financially healthy debtor lacked a valid need to re-organize under the protection of Chapter 11.
Conclusion
Relying on 11 U.S.C. ' 1112(b) the Third Circuit held that a Chapter 11 petition must be filed in good faith. The Third Circuit further held that in order to satisfy the good faith requirement a debtor must have a valid re-organizational purpose. Finally, the Third Circuit explained that a financially healthy company that files only to gain a litigious advantage does not have a valid re-organizational purpose and therefore fails to meet the "good faith" requirement.