Bad Faith Bankruptcy Filing - New Jersey Bankruptcy Law
Posted: Wednesday, June 02, 2004
by New Jersey Lawyer
New Jersey Law Firm
Assume the following scenario: Your largest creditor, an individual, files Chapter 13 bankruptcy on the eve of a judicial sale of his/her assets to be conducted by the sheriff on account of your perfected judgment lien. Your company is the only creditor listed in the debtor’s bankruptcy petition, the debtor lists only nominal assets in his/her petition, and the debtor’s plan proposes a nominal distribution i.e., 2% of his/her total indebtedness to your company. Can the Bankruptcy Court dismiss the debtor’s case when there is only a single creditor? Under certain circumstances and predicated upon a finding of “bad faith", the Bankruptcy Court has the discretion to dismiss a 2- party bankruptcy case.
Pursuant to Section 1307(c) of the Bankruptcy Code, 11 U.S.C. §1307(c), the court may convert a case from Chapter 13 to Chapter 7, or may dismiss a Chapter 13 case, which ever is in the best interests of creditors and the estate, for cause. The statute contains a non-exhaustive list of ten (10) separate factors deemed to constitute “cause" for conversion or dismissal. Id.
As recognized by the Court of Appeals for the Third Circuit Court, there is not an explicit requirement of “good faith" in the filing of a Chapter 13 petition. In re Lilley, 91 F.3d 491, 496 (3d Cir. 1996). In the same decision, however, the Third Circuit confirmed that a lack of good faith in filing of a Chapter 13 petition is sufficient cause for dismissal Id. ( citing In re Love, 957 F.2d 1350, 1354 (7 th Cir. 1992) In re Eisen, 14 F.3d 469, 470 (9 th Cir. 1994 ) In re Gier, 986 F.2d 1326, 1329-30 (10 th Cir. 1993)). MTC, as the party moving for dismissal on the grounds of bad faith, bears the burden of proof. In re Love, supra.
As a prerequisite to confirmation, 11 U.S.C. § 1325(a)(3) explicitly requires that a chapter 13 Plan be “proposed in good faith and not by any means forbidden by law". Several courts have observed that, while there is no explicit requirement for good faith in the filing of a Chapter 13 case, the requirement of good faith as a prerequisite to confirmation of a plan is really the same thing. See e.g., In re Steeley, 243 B.R. 421, 426, n. 7 (Bankr. N.D.Ala. 1999) and Shell Oil Company v. Waldron ( In re Waldron) 785 F.2d 936, 941 (11 th Cir. 1986), cert. dismissed, 478 U.S. 1028 (1986).
The term “good faith" is not specifically defined in the Bankruptcy Code. As one district court judge recognized, “[G]ood faith is a term is incapable of precise definition", In re Goddard, 232 B.R. 233, 237 (D.NJ 1997) (internal citations omitted). Courts consider the “totality of the circumstances" in determining whether a lack of good faith constitutes grounds for dismissal of a Chapter 13 case, or sufficient good faith warrants the confirmation of a Chapter 13 Plan. See In re Lilley, supra In re Love, supra, and In re Goddard, supra.
In Lilley, the Third Circuit set forth the following non-exclusive list of factors to be considered in determining the “totality of the circumstances:
1. The nature of the debt
2. The timing of the petition
3. How the debt arose
4. The debtor’s motive in filing the petition
5. How the debtor’s actions affected creditors
6. The debtor’s treatment of creditors both before and after the petition was filed and
7. Whether the debtor has been forthcoming with the Bankruptcy Court and the creditors.
In re Lilley , 91 F.3d at 496 In re Goddard, 212 B.R. at 238.
Under the guidance of the Third Circuit’s opinion in In re Lilley, the Bankruptcy Court may not consider whether a debt would be nondischargeable in a Chapter 7 proceeding for purposes of dismissal of a case under Section 1307(c). 91 F.3d at 496, n. 2. In addition, the Third Circuit in In re Lilley omits any reference to the dividend to be paid to general unsecured creditors. However, the Honorable Stephen A. Stripp addressed this issue in In re Alicea, 199 B.R. 862 (Bankr. D.N.J. 1996), wherein His Honor held that a “per se minimum payment requirement to unsecured creditors as an element of good faith would infringe upon the desired flexibility of Chapter 13 and is unwarranted."
In In re Goddard, supra,the court focused on consideration of the following principal factors in deciding a motion to dismiss a Chapter 13 case for cause:
1. Whether the debtor has stated his debts and expenses accurately
2. Whether he has made any fraudulent misrepresentations to mislead the Bankruptcy Court or
3. Whether he has unfairly manipulated the Bankruptcy Code.
In re Goddard , 121 B.R. at 240. The court in Goddard nevertheless confirmed that the point of inquiry remains the same i.e., whether the circumstances of the entire case show an abuse of the provisions, purpose, or spirit of Chapter 13 in the proposed plan. Id.
In reviewing the “totality of the circumstances" in the context of a motion to dismiss a Chapter 13 case for bad faith in In re Falotico, 211 B.R. 35, 41 (Bankr. D.N.J. 1999), the Honorable Novalyn L. Winfield commented that a bankruptcy court is a court of equity, and that therefore the totality of the circumstances test should include an analysis of whether the debtor seeks to evoke the bankruptcy court’s jurisdiction in an inequitable fashion. Specifically, Judge Winfield explained as follows:
It is well recognized that bankruptcy courts are courts of equity. Pepper v. Litton, 308 U.S. 295, 304, 60 S.Ct. 238, 84 L.Ed. 281 (1939)(“…a bankruptcy court is a court of equity at least in the sense that in the exercise of the jurisdiction conferred upon it by the act, it applies the principles and rules of equity jurisprudence ."). Thus, the equitable maxim that “one who seeks the aid of equity must do equity" is fully applicable in bankruptcy court. In this court’s view, it is this equitable notion which informs the bankruptcy policy that provides a discharge of debt to the honest but unfortunate debtor. Similarly, implicit in the “totality of the circumstances" test for determination of whether a petition is filed in good faith, is the concern that the statute not be employed in an inequitable fashion. As stated by the court in Eisen, “[a] judge should ask whether the debtor ‘misrepresented facts in his [petition or] plan, unfairly manipulate d the Bankruptcy Code, or otherwise [filed] his Chapter 13 [petition or] plan in an inequitable matter.’" 14 F.3d at 470 (quoting In re Goeb, 675 F.2d 1386, 1391 (9 th Cir. 1982).
Falotico , 231 B.R. at 41. (Emphasis supplied).
B. Dismissal Under The Totality of the Circumstances in 2-Party Bankruptcy Cases.
As Bankruptcy Judge Novalyn L. Winfield recognized in In re Falotico, supra, the inequitable manner in which a Debtor has sought to evoke the Chapter 13 jurisdiction of this Bankruptcy Court should be considered in evaluating the “totality of the circumstances." It is well accepted that a bankruptcy court is not the appropriate forum to litigate a two-party dispute between debtor and creditor. See e.g., In re ABQ-MCB Joint Venture, 153 B.R. 338 (Bankr. D. New Mexico 1993)(Court may properly abstain from hearing involuntary bankruptcy case which is essentially a two-party dispute where creditor has adequate state law remedies, and debtor has no significant assets for bankruptcy court to administer) In re Westerleigh Development Corp., 141 B.R. 38 (Bankr. S.D.N.Y. 1992)(Bankruptcy Court declined to exercise jurisdiction over involuntary Chapter 11 petition filed by a family owned corporation of one of the debtor’s two 50% shareholders, where the petition was filed in order for one shareholder to gain leverage over the other shareholder in a two-party dispute that was being litigated in state court) and In re AXL Industries, Inc., 127 B.R. 482 (S.D.Fla. 1991), aff’d,977 F.2d 598 (11 th Cir. 1992 )(Generally, a bankruptcy court should not take jurisdiction over involuntary bankruptcy petition which is merely a two-party dispute between debtor and petitioning creditor, unless special circumstances exist). This concept was recently reaffirmed by a Virginia bankruptcy court in the context of motion to dismiss a Chapter 13 case on the grounds of bad faith. See In re Herndon, 218 B.R. 821 (Bankr. E.D.Va. 1998).
In Herndon, the debtor filed a Chapter 13 petition listing five (5) creditors with debts totaling $6,971.00, including the claim of Nelly Wren, a 90-year old woman suffering from Alzheimer’s disease, scheduled in the amount of $1.00. The debtor proposed a 36 month plan providing for a six percent (6%) distribution to her creditors. Ms. Wrenn’s legal guardian filed a motion requesting, among other relief, dismissal or conversion of the case to Chapter 7, and an objection to confirmation of the debtor’s plan. The guardian also filed a proof of claim in the amount of $148,027.34 The amount of the claim was derived from a complaint filed in pre-petition state court action, in which Wrenn’s legal guardian alleged that the debtor, who was a friend, bookkeeper and tax preparer for Wrenn, fraudulently misappropriated and converted approximately $150,000.00 from the elderly and disabled Wrenn. “There was evidence available to demonstrate that through various means, Wrenn’s funds went to the debtor and members of her family." 218 B.R. at 823.
The Chapter 13 trustee in Herndon also filed an objection to confirmation, which resulted in the debtor filing an amended plan providing for the payment of $46.19 weekly for 2 months and then $127.02 thereafter for 34 months. The modified plan proposed the same six percent (6%) distribution to unsecured creditors. The court in Herndon dismissed the debtor’s Chapter 13 case on a finding of bad faith. The principal factors in the Court’s decision to dismiss the case for bad faith were as follows: (i) the petition was filed on the eve of the state court lawsuit alleging that the debtor had embezzled a substantial sum from Wrenn (ii) the preliminary evidence suggested that Wrenn had a meritorious claim, derived from embezzlement, and the debtor had not offered any explanation (iii) the case essentially constituted at two-party dispute between the debtor and Wrenn’s legal guardian, as Wrenn’s debt was the only significant debt listed in the petition (iv) the plan provided for a nominal payment on a potentially nondischargeable debt. 218 B.R. at 825.
In fact, it has been held that courts must be more circumspect in weighing the crucial issue of good faith when the genesis of the major obligation sought to be wiped out under Chapter 13 plan is rooted in criminal conduct. In re Sotter, 28 B.R. 201 (Bankr. S.D.N.Y. 1983). See also In re Ristic, 142 B.R. 856 (E.D.Wis. 1992)(court held that Chapter 13 plan failed to satisfy good faith requirements where the an imprisoned debtor sought to pay less than 1% of the claim of his largest creditor, and the costs of maintaining the case would exceed the Chapter 13 trustee’s fees).
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