Filed: Sep. 20, 2004
Latest Update: Mar. 02, 2020
Summary: Opinions of the United 2004 Decisions States Court of Appeals for the Third Circuit 9-20-2004 In Re: Integrated Precedential or Non-Precedential: Precedential Docket No. 04-2411 Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_2004 Recommended Citation "In Re: Integrated " (2004). 2004 Decisions. Paper 273. http://digitalcommons.law.villanova.edu/thirdcircuit_2004/273 This decision is brought to you for free and open access by the Opinions of the United S
Summary: Opinions of the United 2004 Decisions States Court of Appeals for the Third Circuit 9-20-2004 In Re: Integrated Precedential or Non-Precedential: Precedential Docket No. 04-2411 Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_2004 Recommended Citation "In Re: Integrated " (2004). 2004 Decisions. Paper 273. http://digitalcommons.law.villanova.edu/thirdcircuit_2004/273 This decision is brought to you for free and open access by the Opinions of the United St..
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Opinions of the United
2004 Decisions States Court of Appeals
for the Third Circuit
9-20-2004
In Re: Integrated
Precedential or Non-Precedential: Precedential
Docket No. 04-2411
Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_2004
Recommended Citation
"In Re: Integrated " (2004). 2004 Decisions. Paper 273.
http://digitalcommons.law.villanova.edu/thirdcircuit_2004/273
This decision is brought to you for free and open access by the Opinions of the United States Court of Appeals for the Third Circuit at Villanova
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PRECEDENTIAL
Before: SMITH, BECKER, and
UNITED STATES COURT GREENBERG, Circuit Judges
OF APPEALS
FOR THE THIRD CIRCUIT (Filed: September 20, 2004)
_________ Seth P. Waxman (Argued)
Craig Goldblatt
Case No: 04-2411 Wilmer Cutler Pickering
__________ Hale & Dorr LLP
2445 M Street, NW
IN RE: INTEGRATED TELECOM Washington, DC 20037
EXPRESS, INC.
a/k/a INTEGRATED TECHNOLOGY Christopher J. Meade
EXPRESS, INC. Wilmer Cutler Pickering
a/k/a DELAWARE INTEGRATED Hale & Dorr LLP
TELECOM EXPRESS, INC., 399 Park Ave
30th Floor
Debtor New York, NY 10022
NM SBPCSLDHB, L.P., Counsel for Appellant
Appellant Laura D. Jones
David W. Carickhoff, Jr.
v. Pachulski, Stang, Ziehl, Young,
Jones & Weintraub P.C.
INTEGRATED TELECOM EXPRESS, 919 North Market Street
INC.; P.O. Box 8705, 16th Floor
and THE OFFICIAL COMMITTEE OF Wilmington, DE 19801
EQUITY HOLDERS, et al.
Tobias S. Keller (Argued)
On Appeal From The United States Pachulski, Stang, Ziehl, Young,
District Court Jones & Weintraub P.C.
For The District Of Delaware Three Embarcadero Center
(Civ. A. No. 03-236-KAJ) Suite 1020
San Francisco, CA 94111
District Judge: The Honorable Kent A.
Jordan Counsel for Appellee Integrated Telecom
__________ Express, Inc.
Argued August 3, 2004 Kevin Gross
__________ Rosenthal, Monhait, Gross & Goddess
919 North Market Street, Suite 1401 Bankruptcy Code. A p p e l l a nt
P.O. Box 1070 NMSBPCSLDHB, L.P. (the “Landlord”)
Wilmington, DE 19899 appeals from an order of the District Court
affirming the Bankruptcy Court’s denial of
Ali M. Mojdehi (Argued) its motion to dismiss for lack of good faith.
Baker & McKenzie The Landlord contends that the Debtor,
101 West Broadway Integrated Telecom Express, Inc.
12th Floor (“Integrated”), was never in financial
San Diego, CA 92101 distress and that the petition in this case
was instead filed to frustrate the Landlord’s
Counsel for Appellee Official Committee claims and to increase the distribution of
of Equity Security Holders the Debtor’s estate to Integrated’s
shareholders at the Landlord’s expense.
Robert K. Rasmussen These contentions are corroborated by the
Vanderbilt Law School record. First, according to schedules filed
131 21st Ave. South with the Bankruptcy Court, Integrated had
Nashville, TN 37240 $105.4 million in cash and $1.5 million in
other assets at the time that it filed for
G. Marcus Cole bankruptcy, and yet the Landlord’s proof of
Stanford Law School claim lists the present discounted value of
559 Nathan Abbott Way Integrated’s le as e o b l ig a t i o ns at
Stanford, CA 94305-8610 approximately $26 million. Integrated’s
schedules also list miscellaneous liabilities
David A. Skeel, Jr. of approximately $430,000. Thus
University of Pennsylvania Law School Integrated was highly solvent and cash rich
3400 Chestnut Street at the time of the bankruptcy filing. Even
Philadelphia, PA 19104 if the IPO class action claim, which was
capped at $25 million with Integrated’s
Amicus Curiae in Support of Appellant liability limited to a $5 million reserve (the
balance to be paid by insurance) was listed
____________ at its full alleged value, Integrated was still
solvent at the time of filing. Second, in a
OPINION smoking gun resolution approved by the
___________ Board, and notwithstanding its strong
financial position, Integrated authorized a
letter to the Landlord threatening that if it
SMITH, Circuit Judge. did not enter into a settlement of the lease
This appeal tests the limits of the in the amount of at least $8 million,
good faith requirement applicable to Integrated would file for bankruptcy so as
petitions filed under Chapter 11 of the to take advantage of § 502(b)(6), which
2
sharply limits the amount that a landlord million. Integrated hired a management
can recover in bankruptcy for damages and technology consulting firm in
resulting from the termination of a lease. December 2001 to help evaluate
Integrated’s operating alternatives.
The issue on appeal is whether, on
Integrated also retained Lehman Brothers,
the facts of this case, a Chapter 11 petition
an investment bank, in February 2002, to
filed by a financially healthy debtor, with
assist in identifying, soliciting, and
no intention of reorganizing or liquidating
evaluating proposals for a sale or merger of
as a going concern, with no reasonable
Integrated or its assets. Unable to find a
expectation that Chapter 11 proceedings
third party willing to enter into such a
will maximize the value of the debtor’s
transaction, and unable to identify an
estate for creditors, and solely to take
alternative business model, Integrated’s
advantage of a provision in the Bankruptcy
Board of Directors prepared a plan for the
Code that limits claims on long-term
liquidation and dissolution of the company
leases, complies with the requirements of
under state law.
the Bankruptcy Code. We conclude that
such a petition is not filed in good faith and In November 2001, a securities class
will therefore reverse. action styled Richmon v. Integrated
Telecom Express, Inc., No. 01-CV-10108-
I.
SAS, was filed in the Southern District of
Integrated was a supplier of New York naming Integrated as a
software and equipment to the broadband defendant, along with certain officers,
communications industry. In the summer directors, and underwriters of Integrated.
of 2000, Integrated negotiated a lease of The class consists of individuals who
real property in Silicon Valley with the purchased Integrated stock between August
Landlord. After several months of 18, 2000, and December 6, 2000. The
negotiation, during which the Landlord class action alleges claims in the amount of
evaluated Integrated’s business condition $93.24 million for various violations of the
and reviewed the company’s prospectus, Securities Act of 1933 and the Securities
Integrated and the Landlord executed a Exchange Act of 1934 in connection with
lease for a term of ten years beginning on Integrated’s initial public offering of
February 23, 2001, with a monthly base securities. Similar lawsuits concerning
rent of $200,000, increasing 5 percent more than 300 other companies’ initial
annually. The Landlord was aware of the public offerings have been filed and
financial risks associated with Integrated’s coordinated as In re Initial Public Offering
business and willingly accepted those risks. Securities Litigation, No. 21-MC-00092-
SAS (S.D.N.Y.).
2001 was a very poor year for
Integrated. The market for many of the On April 18, 2002, Integrated’s
company’s products deteriorated, causing Board approved a Plan of Complete
Integrated to suffer net losses of $36.2 Liquidation and Dissolution under
3
Delaware law. The two major issues to be reviewed with the Board the
resolved prior to dissolution were (1) the draft letter to the landlord (a
disposition of Integrated’s intellectual copy of w hich w as
property rights and (2) its remaining previously distributed to the
obligations under the lease. In May of Board).
2002, the Board approved the sale of
Ms. Murray then reviewed
substantially all of Integrated’s intellectual
with the Board the timeline .
property and related assets to Real Com, a
. . for a bankruptcy filing and
corporation to be formed by certain of
related bankruptcy
Integrated’s officers and directors. The
procedures.
proposed purchase price was $1.5 million
plus assumption of Integrated’s technical Various members of the
support and warranty obligations. Board then asked questions
of Ms. Murray related to the
Thereafter, Integrated attempted to
draft letter to the landlord
negotiate an accord and satisfaction of its
and the procedures for, and
lease. Integrated asserts that, “[d]uring this
implications of, a possible
time, Debtor first became aware that it
bankruptcy filing by the
might use Chapter 11 to, among other
Company. A discussion
things, address Landlord’s claims.”
among the Board ensued,
Appellee’s Br. at 6-7. On August 13,
including a discussion of the
2002, the Board authorized a Chapter 11
costs and potential benefits
filing in the event that the Landlord would
and risks of proceeding with
not accept $8 million as an accord and
a bankruptcy filing.
satisfaction of Integrated’s obligations
under the lease. The minutes of the August Following that discussion,
13 Board meeting state, in pertinent part: Mr. Regel asked the Board
for authority for
Mr. Regel [Integrated’s
management to negotiate a
CEO] updated the Board on
settlement with the landlord
his discussions with the
in an amount in the range of
landlord subsequent to the
$6 to $7 million. A further
last board meeting. Mr.
discussion among the Board
Regel noted that the landlord
ensued regarding the costs
did not appear to believe that
associated with a bankruptcy
t h e C o m p a ny would
filing and potential costs of
seriously consider making a
any litigation. A fter
bankruptcy filing.
additional discussion, the
Ms. Murray [of the law firm Board approved the
Murray & Murray] next following resolutions:
4
RESOLVED: That the RESOLVED FURTHER:
officers of the Company are, That the officers of the
and each of them hereby is, Company be, and each of
authorized and directed to them hereby is, authorized
send the landlord the letter and directed to instruct
prepared by Murray and bankruptcy counsel to begin
Murray in substantially the to prepare the necessary
form reviewed with the paperwork for a bankruptcy
Board. filing.
RESOLVED FURTHER: RESOLVED FURTHER:
That the officers of the That if the landlord is not
Company are, and each of willing to enter into a
them hereby is, authorized settlement agreement with a
and directed to negotiate a maximum amount of $8
settlement with the landlord million, then the officers of
up to a maximum settlement the Company shall be, and
amount of $7 million. each of them hereby is,
authorized and empowered
RESOLVED FURTHER:
on behalf of, and in the
That the Board hereby
name of, the Company to
appoints . . . a special
execute and verify or certify
c o m m it t e e ( t h e
a petition under Chapter 11
“Committee”) that is hereby
of the Bankruptcy Code and
empowered on behalf of the
to cause the same to be filed
Board to authorize the
in the appropriate United
officers of the Company to
States Bankruptcy Court
enter into a settlement with
(the “Bankruptcy Court”) at
the landlord up to a
such time as said authorized
maximum settlement amount
officer executing the same
of $8 million.
shall determine.
RESOLVED FURTHER:
On August 15, 2002, Integrated’s
That the officers of the
bankruptcy counsel sent the Landlord a
Company shall be required
letter stating that, if the Landlord was
to seek approval from the
unwilling to settle, the Debtor was
Board prior to entering into
prepared to avail itself of various
an [sic] settlement with the
provisions in the Bankruptcy Code,
landlord in excess of $8
including the cap on landlords’ claims set
million.
5
forth in 11 U.S.C. § 502(b)(6). 1 The letter asserted that “even if [Integrated]
were to file bankruptcy solely to cap the
Lessor’s claim using Bankruptcy Code §
1 502(b)(6), a use for which this Code
11 U.S.C. § 502(b)(6) limits the
section is intended, [Integrated] would not
amount that a landlord can recover in
violate the good faith filing doctrine.”
bankruptcy for damages resulting from
the termination of a lease. Under § No settlement was reached.
502(b)(6), a landlord can recover rent that
Proceedings in the Bankruptcy
has accrued as of the filing of the
Court
petition, but may not recover rent
remaining on the lease beyond one year’s Integrated filed a voluntary petition
rent or 15 percent of the remaining rent for relief under Chapter 11 of the
(not to exceed three years), whichever is Bankruptcy Code on October 8, 2002.
greater: According to schedules filed with the
Bankruptcy Court, Integrated had $105.4
(a) A claim or interest, proof of which is million in cash and $1.5 million in other
filed under section 501 of this title, is assets at the time that it filed for
deemed allowed, unless a party in interest bankruptcy. The Landlord filed a proof of
. . . objects. claim listing the present discounted value
of Integrated’s lease obligations at
(b) . . . if such objection to a claim is approximately $26 million. Integrated’s
made, the court, after notice and a schedules also list miscellaneous liabilities
hearing, shall determine the amount of of approximately $430,000.
such claim in lawful currency of the
Immediately after Integrated filed
United States as of the date of the filing
its petition, Integrated attempted to address
of the petition, and shall allow such claim
in such amount, except to the extent
that—
lease, following the earlier of—
...
(i) the date of the filing of the petition;
(6) if such claim is the claim of a lessor and
for damages resulting from the
termination of a lease of real property, (ii) the date on which such lessor
such claim exceeds— repossessed, or the lessee surrendered,
the leased property; plus
(A) the rent reserved by such lease,
without acceleration, for the greater of (B) any unpaid rent due under such lease,
one year, or 15 percent, not to exceed without acceleration, on the earlier of
three years, of the remaining term of such such dates . . . .
6
the two major obstacles to dissolution: the did not expand on this statement except to
sale of its intellectual property assets and stress that Integrated “was losing a lot of
its remaining obligations under the lease. money.” The court characterized the
On October 9, 2002, the day after company’s financial losses as “dramatic.”
Integrated filed its petition, Integrated According to the court, Integrated “was
moved to sell its intellectual property assets experiencing a dramatic downward spiral”
at a public auction. The Official in September 2001. As such, the court
Committee of Equity Security Holders (the concluded that “the Board had an
“OCESH”) objected to the adequacy of obligation, and appropriately exercised
Integrated’s efforts to market the assets. that obligation, to give the investors their
Ultimately, Integrated was able to money back.”
renegotiate the sale and to introduce other
Alternatively, the Bankruptcy Court
bidders. As a result, a new agreement was
held that, “even assuming” that
reached with Real Com for some, but not
Integrated’s stated reasons for filing the
all, of the assets for $2 million, an increase
petition were not “particularly persuasive,”
of $500,000. The remaining assets were
Integrated’s desire to take advantage of the
sold for $500,000 after confirmation of the
§ 502(b)(6) cap on landlords’ claims was
plan of reorganization.
not a sufficient basis on which to dismiss
Also on October 9, 2002, Integrated the petition “as a matter of law”:
moved to reject the lease. The Landlord
But even assuming that
opposed the motion and, on October 28,
those other factors are not
2002, filed a motion to dismiss the Chapter
particularly persuasive, even
11 proceeding on the ground that the
assuming or accepting the
petition was not filed in good faith. On
l a n d l o rd’s p o si t io n ,
January 8, 2003, the Bankruptcy Court
particularly illustrated by the
conducted an evidentiary hearing on the
Board of Directors’ minutes
motion to dismiss and the motion to reject
of August 13 of ‘02, that the
the lease during which it heard evidence
principal reason for the
regarding Integrated’s decision to file for
Chapter 11 case was to cap
Chapter 11. After the close of evidence,
the damage claim for the
the Bankruptcy Court determined that oral
landlord, I conclude that as
argument was unnecessary and denied the
a matter of law, that is not a
motion to dismiss from the bench.
debilitating fact. I held in
The Bankruptcy Court explained at [In re PPI Enterprises
the hearing that Integrated “offered a (U.S.), Inc., 228 B.R. 339
number of reasons for the filing of the (Bankr. D. Del. 1998), aff’d,
bankruptcy case,” and that the court
324 F.3d 197 (3d Cir.
“believe[d] there is validity to a number of 2003)], and other cases have
those considerations.” The court, however, held, that it does not
7
establish bad faith for a was not leveraged. And
debtor to file a chapter 11 instead of the significant
case for the purpose of distribution going to debt
taking advantage of holders . . . it’s going to go
prov isions wh ich alte r to the shareholders.
pre-petition rights, including
The Bankruptcy Court then went on to
altering the rights of a
discuss “other decisions that agree with
landlord under State law.
that proposition, namely that a solvent
The Bankruptcy Court was guided debtor can avail itself of the 502(b)(6)
by the following proposition: “[A]s the cap,” focusing in particular on In re
case law clearly indicates, not limited to Sylmar Plaza, L.P., 314 F.3d 1070 (9th
my case [referring to the Bankruptcy Cir. 2002), and characterizing Sylmar as
Judge’s decision in PPI], the solvency of “almost on all fours with the situation
the debtor and the fact that the equity before me.”
interest holders will receive a distribution
With respect to the equities of the
does not serve as the basis for a finding of
case, the Bankruptcy Court found that,
bad faith.” The court thus saw no
although the shareholders would realize a
significance in the fact that the § 502(b)(6)
“benefit” from the bankruptcy in the form
cap would operate solely to the benefit of
of a “significant distribution,” “the
equity holders, as opposed to creditors:
shareholders are not coming out whole by
What I think is also any means.” The court concluded that
significant in this case is that “obviously you can’t consider that they
. . . this debtor had no [i.e., the shareholders] are being treated
significant debt. . . . [to] any windfall.” Conversely, the court
found that the Landlord elected to “ride
The difference in this
with the bulls,” when it entered into the
case is that the company was
lease with Integrated, and that, as a
not at all leveraged. And if
“sophisticated individual” who “took the
the distribution were, for the
risk [hoping] that his instincts were right,”
most part, or totally to go to
he must “suffer the consequences” of his
the creditors, there would be
instincts being wrong. On January 30,
no basis for the landlord to
2003, the Bankruptcy Court issued an
complain regarding some
order formally denying the motion “for the
equitable principle.
reasons stated on the record at the
But I don’t think the Hearing.”
Code makes any distinction.
The B ankruptcy Court Confirm s
And I think that the—why
Integrated’s Plan of Liquidation
this case is different is
because the debtor simply The Bankruptcy Court held a
8
confirmation hearing on April 7, 2003, and that regard, it’s also worth
issued an order confirming Integrated’s noting that [this] Chapter 11
proposed plan of liquidation over the case had the effect on the
Landlord’s objections on April 16, 2003. securities law plaintiffs
Applying § 502(b)(6), the Landlord’s claim similar to its effect on this
was reduced from $26 million to $4.3 landlord. It effectively
million. reduced the recovery by the
securities law claimants by
The plan of liquidation did not
t r e a ti n g th e m lik e
completely resolve the securities class
shareholders pursuant to
action. Instead, the plan reserved $5
Section 510(b).[ 2 ]
million of the debtor’s estate to satisfy any
judgment that might be entered in the Could the securities
securities class action. When added to $20 law plaintiffs obtain a bad
million in insurance coverage available to faith ruling in this case? I
Integrated, the plan effectively limited any don’t think so for essentially
potential judgment in the securities class the same reasons I think that
action to $25 million. The securities class the landlord cannot.
voted in favor of the plan of liquidation.
With respect to the
The Landlord appealed to the securities law action, I am
District Court and moved the Bankruptcy puzzled to understand how
Court to stay confirmation of the plan that claim could be resolved
pending appeal. The Bankruptcy Court in a non-bankruptcy law
addressed the Landlord’s motion for a stay liquidation context absent a
at an April 29, 2003 hearing. The final resolution of that
Bankruptcy Court reaffirmed its earlier claim. In a non-bankruptcy
ruling on the Landlord’s motion to dismiss, law context, the securities
making several “observations to amplify law plaintiffs would have
the record on the issue.” Specifically, the
Bankruptcy Court elaborated on the
significance of the securities class action: 2
11 U.S.C. § 510(b) subordinates
claims for damages arising from the
There is nothing in the law purchase or sale of a security of the
to sugg est that the debtor to all claims and interests that are
corporation cannot avail senior or equal to the claim or interest
itself to the distribution represented by such security. Where, as
scheme set forth in the here, the security is common stock, the
Bankruptcy C ode in claim has the same priority as common
effecting that liquidation. In stock. Collier on Bankruptcy §§ 510.01,
510.04[1] (15th ed. 2004).
9
h a d a v e r y s t r at e g ic THE COURT: Well,
advantage, namely so long as I—they could. But I believe
there w as a po ssible they would be in breach of
recovery again st the their fiduciary duty if they
corporation, the liquidation did, and I made this
would be stalled indefinitely. observation back in January.
The Bankruptcy Court nevertheless stayed
The Bankruptcy Court also its confirmation order pending appeal, on
commented on Integrated’s financial the condition that the Landlord post a $2.5
affairs leading up to its decision to file for million bond.
Chapter 11:
Appeal to the District Court
THE COURT: Are you
The District Court affirmed,
sa yi ng that Integrate d
holding that the Bankruptcy Court did not
Tele com is a healthy
abuse its discretion in denying the
company?
Landlord’s motion to dismiss. The District
MR. HAZELTINE: Your Court concluded that the Bankruptcy Court
Honor, Integrated Telecom made two specific findings of fact: (1) that
as it sits here today is a very in September 2001 the Debtor was in
healthy company. At the “financial distress”; and (2) that the Board,
t im e i t e n t e r e d f o r consistent with its fiduciary responsibility,
bankruptcy it was a very properly pursued liquidation in order to
healthy company. They fulfill its obligations to its investors. The
had— District Court did not disturb either
finding.
THE COURT: They’re out
of business, aren’t they? The District Court understood the
Bankruptcy Court to have alternatively
MR. HAZELTINE: They’re
ruled, as a matter of law, that “even if the
out of business. But their
Debtor’s principal reason for filing its
balance sheet looks great.
Chapter 11 case was to cap the Landlord’s
They have $105 million in
damage claim, that alone was insufficient
assets, $28 million in debts if
to establish bad faith.” The District Court
the landlord’s claim is not
concluded that the Bankruptcy Court’s
capped.
legal ruling “was based on a sound
They could become interpretation of relevant case law from
an investment company, this and other jurisdictions, and does not
invest that money and constitute an abuse of discretion.” The
make—make money. They District Court rejected the Landlord’s
just— argument that “permitting a solvent
10
corporation to invoke the landlord cap 1112(b) unless filed in good faith, and the
would permit an end run around a core burden is on the bankruptcy petitioner to
principle of bankruptcy law, the ‘absolute establish that its petition has been filed in
priority rule’—that is, that creditors must good faith. In re SGL Carbon Corp., 200
be paid in full before stockholders can F.3d 154, 159-62 (3d Cir. 1999); accord
retain equity interests for any purpose.” Solow v. PPI Enters. (U.S.), Inc. (In re PPI
Like the Bankruptcy Court, the District Enters. (U.S.), Inc.), 324 F.3d 197, 211 (3d
Court observed that insolvency is not a Cir. 2001) (“The debtor bears the burden
prerequisite to filing under Chapter 11. of establishing good faith.”). 3 Whether the
Regardless, in light of the Bankruptcy good faith requirement has been satisfied
Court’s finding that Integrated was is a “fact intensive inquiry” in which the
“experiencing a dramatic downward spiral” court must examine “the totality of facts
and that filing a Chapter 11 petition and circumstances” and determine where
fulfilled the Board’s obligations to a “petition falls along the spectrum
shareholders, the District Court concluded ranging from the clearly acceptable to the
that no such “end run” had taken place. patently abusive.”
Id. at 162. We
Although the District Court affirmed the therefore review for abuse of discretion the
Bankruptcy Court’s ruling, the District Bankruptcy Court’s refusal to dismiss a
Court extended the Bankruptcy Court’s Chapter 11 petition for want of good faith.
stay of the confirmation order. Solow v. PPI Enters. (U.S.), Inc. (In re PPI
Enters. (U.S.), Inc.), 324 F.3d 197, 211 (3d
The Landlord filed a timely appeal
Cir. 2003). “[A]n abuse of discretion
from the District Court’s order. We
exists where the district court’s decision
expedited the appeal and stayed the
Bankruptcy Court’s confirmation order
pending the appeal. Jurisdiction in the
3
District Court was proper under 28 U.S.C. Under 11 U.S.C. § 1112(b), “the
§ 158(a), and we exercise jurisdiction court may convert a case under [Chapter
under 28 U.S.C. § 158(d). Although this 11] to a case under Chapter 7 . . . or may
Court’s jurisdiction is over the decision of dismiss a case under this chapter,
the District Court, 28 U.S.C. § 158(d), whichever is in the best interest of
“review of the District Court’s decision creditors and the estate, for cause.” The
effectively amounts to review of the statute lists 10 non-exhaustive factors
bankruptcy court’s opinion in the first that may amount to cause. H.R. Rep. No.
instance.” In re Hechinger Inv. Co. of 95-595, at 406 (1977), reprinted in 1978
Del., 298 F.3d 219, 224 (3d Cir. 2002). U.S.S.C.A.N. 5963, 6362 (“[The] list
[contained in § 1112(b) ] is not
II.
exhaustive. The court will be able to
Chapter 11 bankruptcy petitions are consider other factors as they arise, and
subject to dismissal under 11 U.S.C. § to use its equitable powers to reach an
appropriate result in individual cases.”).
11
rests upon a clearly erroneous finding of Court has identified two of the basic
fact, an errant conclusion of law, or an purposes of Chapter 11 as (1) “preserving
improper application of law to fact.” SGL going concerns” and (2) “maximizing
Carbon, 200 F.3d at 159 (quoting ACLU v. property available to satisfy creditors.”
Black Horse Pike Reg’l Bd. of Ed., 84 F.3d Bank of Am. Nat’l Trust & Sav. Ass’n v.
1471, 1476 (3d Cir. 1996)). 203 N. LaSalle St. P’ship,
526 U.S. 434,
453 (1999); accord Toibb v. Radloff, 501
At its most fundamental level, the
U.S. 157, 163-64 (1991) (discussing “the
good faith requirement ensures that the
congressional purpose of deriving as much
Bankruptcy Code’s careful balancing of
value as possible from the debtor’s
interests is not undermined by petitioners
estate”). Each of these purposes informs
whose aims are antithetical to the basic
our application of the good faith
purposes of bankruptcy:
requirement:
“[A good faith standard]
“Review and analysis of
furthers the balan cin g
[the bankruptcy laws and
process between the interests
relevant cases] disclose a
of debtors and creditors
common theme and
which characterizes so many
objective [underlying the
provisions of the bankruptcy
reorganization provisions]:
laws and is necessary to
avoidance of the
legitimize the delay and
consequences of economic
costs imposed upon parties
d is m em b e rm e n t a n d
to a bankruptcy.
l i q u i d a t io n , a n d t h e
Requirement [sic] of good
preservation of ongoing
faith prevents abuse of the
values in a manner which
bank ruptc y process by
does equity and is fair to
debtors whose overriding
rights and interests of the
motive is to delay creditors
parties affected. But the
without benefitting them in
perimeters of this potential
any way . . . .”
mark the borderline between
SGL Carbon, 200 F.3d at 161-62 (quoting fulfillment and perversion;
Little Creek Dev. Co. v. Commonwealth between accomplishing the
Mortgage Corp. (In re Little Creek Dev. objectives of rehabilitation
Co.),
779 F.2d 1068, 1072 (5th Cir. 1986)); and reorganization, and the
see also Carolin Corp. v. Miller, 886 F.2d use of these statutory
693, 698 (4th Cir. 1989) (good faith provisions to destroy and
requirement is “indispensable to proper undermine the legitimate
accomplishment of the basic purposes of rights and interests of those
Chapter 11 protection”). The Supreme intended to benefit by this
12
sta t utory p o licy. T hat going concern or maximizing the value of
borderline is patrolled by the debtor’s estate, and (2) whether the
courts of equity, armed with petition is filed merely to obtain a tactical
the doctrine of ‘good faith’ . litigation advantage. SGL Carbon, 200
. . .” F.3d at 165.
SGL Carbon, 200 F.3d at 161 (quoting In It is easy to see why courts
re Victory Constr. Co., Inc.,
9 B.R. 549, have required Chapter 11
558 (Bankr. C.D. Cal. 1981), order stayed petitioners to act within the
Hadley v. Victory Constr. Co., Inc. (In re scope of the bankruptcy
Victory Constr. Co., Inc.),
9 B.R. 570 laws to further a valid
(Bankr. C.D. Cal. 1981)); see also Marsch reorganizational purpose.
v. Marsch (In re Marsch),
36 F.3d 825, 828 Chapter 11 vests petitioners
(9th Cir. 1994) (“The test is whether a with considerable
debtor is attempting to unreasonably deter powers—the automatic stay,
or harass creditors or attempting to effect a the exclusive right to
speedy, efficient reorganization on a propose a reorganization
feasible basis.”); United Sav. Ass’n of Tex. plan, the discharge of debts,
v. Timbers of Inwood Forest Assocs., Ltd. etc.— that can impose
(In re Timbers of Inwood Forest Assocs., significant hardship on
Ltd.),
808 F.2d 363, 373 (5th Cir. 1987) (en particular creditors. When
banc) (stating that if Chapter 11 plan does financially troub led
not have a rehabilitative purpose, the petitioners seek a chance to
“statutory provisio ns designed to remain in business, the
accomplish the reorganization objective exercise of those powers is
become destructive of the legitimate rights justified. But this is not so
and interests of creditors, the intended when a petitioner’s aims lie
beneficiaries”); Connell v. Coastal Cable outside those of th e
T.V., Inc. (In re Coastal Cable T.V., Inc.), Bankruptcy Code.
709 F.2d 762, 764 (1st Cir. 1991) (Breyer,
J.) (stating that there must be “some
r e l a ti o n — a t l e a s t a n a r g u a b l e
Id. at 165-66.4 Likewise, “because filing a
relation—between the chapter 11 plan and
the reorganization-related purposes that the
4
chapter was designed to serve”). In SGL Carbon, we used the phrase
“a valid reorganizational purpose”
Our cases have accordingly focused
because that case involved a plan of
on two inquiries that are particularly
reorganization. See SGL Carbon, 200
relevant to the question of good faith: (1)
F.3d at 167. Reorganization, however, is
whether the petition serves a valid
not the only “appropriate use of Chapter
bankruptcy purpose, e.g., by preserving a
11 since the Code clearly contemplates
13
Chapter 11 petition merely to obtain tactical litigation advantages is not within
‘the legitimate scope of the bankruptcy
laws,’ courts have typically dismissed
liquidating plans under 11 U.S.C. §
Chapter 11 petitions under these
1123(b)(4), whereby a debtor may
circumstances as well.” Id. at 165
develop a Chapter 11 plan to sell off all
(quoting In re Marsch, 36 F.3d at 828); see
of its assets.”
PPI, 324 F.3d at 211;
also Furness v. Lilienfield, 35 B.R. 1006,
accord 11 U.S.C. § 1123(b)(4) (“[A] plan
1013 (D. Md. 1983) (“The Bankruptcy
may . . . provide for the sale of all or
provisions are intended to benefit those in
substantially all of the property of the
genuine financial distress. They are not
estate, and the distribution of the
intended to be used as a mechanism to
proceeds of such sale among holders of
orchestrate pending litigation.”).
claims or interests . . . .”). Yet liquidation
plans, no less than reorganization plans, A.
must serve a valid bankruptcy purpose.
A s the Ban krup tcy C ourt
That is, they must either preserve some
recognized, Integrated is unquestionably
going concern value, e.g., by liquidating a
“out of business,” and therefore has no
company as a whole or in such a way as
going concern value to preserve in Chapter
to preserve some of the company’s
11 through reorganization or liquidation
goodwill, or by maximizing the value of
under the Bankruptcy Code. The question
the debtor’s estate.
therefore becomes whether Integrated’s
p e t i ti o n m i g h t r e as o n a b l y h a v e
We therefore reject the OCESH’s
“maximiz[ed] the value of the bankruptcy
argument that the good faith inquiry
estate.” Toibb, 501 U.S. at 163; accord
applies with less force to liquidation
203 N. LaSalle, 526 U.S. at 453. For the
plans because, since ownership is not
reasons that follow, we conclude that it
allowed to retain an interest in the
would not.
reorganized entity, the potential for bad
faith is reduced. The good faith To say that liquidation under
requirement is necessitated as much by Chapter 11 maximizes the value of an
the hardship of Chapter 11 to certain entity is to say that there is some value that
interests as it is by the benefit to others. otherwise would be lost outside of
SGL Carbon, 200 F.3d at 161-62, 165-66. ba nk ru pt cy. E l i z a b e th W a r r e n ,
Moreover, the facts of this case Bankruptcy Policymaking In an Imperfect
demonstrate the fallacy of the OCESH’s World,
92 Mich. L. Rev. 336, 350 (1993)
argument. While the owners of (“Two empirically based economic
Integrated may never recover the full assumptions underlie the attempt to
value of their investments, they stand to preserve the value of a failing company:
reap a substantial gain through (1) orderly liquidation is likely to produce
bankruptcy, at the expense of the more value— or to avoid more loss—than
company’s sole creditor.
14
piecemeal liquidation; and (2) going- Inc., 871 F.2d 1023, 1027 (11th Cir. 1989)
concern value is likely to be higher than (recognizing that one factor relevant to
liquidation value.”); Collier on Bankruptcy good faith is “whether the debtor is
¶ 1108.12 (“[W]here liquidation is ‘financially distressed’” and affirming
appropriate, the Code contemplates orderly dismissal of petition for, inter alia, use of
liquidation and not a ‘fire sale.’”). At its bankruptcy proceedings despite the
most basic level, the Bankruptcy Code apparent good financial health of the
maximizes value by alleviating the problem debtor”); Little
Creek, 779 F.2d at 1072
of financial distress. See Thomas H. (“Determining whether the debtor’s filing
Jackson, The Logic and Limits of for relief is in good faith depends largely
Bankruptcy Law 10 (1986) (“The basic upon the bankruptcy court’s on-the-spot
problem that bankruptcy law is designed to evaluation of the debtor’s financial
handle, both as a normative matter and as condition, motives, and the local financial
a positive matter, is that the system of realities.”); In re The Bible Speaks, 65
individual creditor remedies may be bad B.R. 415, 424-26 (Bankr. D. Mass. 1986)
for the creditors as a group when there are (concluding that, despite the absence of a
not enough assets to go around.”). As statutory financial eligibility standard in
Integrated conceded at oral argument, good Chapter 11, “[t]he legislative history [to
faith necessarily requires some degree of the Bankruptcy Code] indicates that
financial distress on the part of a debtor. Congress intended Chapter 11 to be
See SGL
Carbon, 200 F.3d at 166 (“Courts, resorted to by business entities which are
therefore, have consistently dismissed experiencing some type of financial
Chapter 11 petitions filed by financially difficulty”); In re Talladega Steaks, Inc.,
healthy companies with no need to
50 B.R. 42, 44 (Bankr. N.D. Ala. 1985)
reorganize under the protection of Chapter (dismissing petition w here d ebtor
11.” (emphasis added)); Coastal Cable, “presented no evidence that
financial
709 F.2d at 765 (“To meet the ‘good faith’ difficulties had precipitated the filing of
requirement . . . many courts have held that the petition and indeed testified that the
a reorganization plan must bear some debtor’s debts and other financial
relation to the statutory objective of obligations were substantially current”).
resuscitating a financially troubled
To be sure, a debtor need not be
corporation.” (emphasis added)); Baker v.
insolvent before filing for bankruptcy
Latham Sparrowbrush Assocs. (In re
protection. SGL Carbon, 200 F.3d at 163-
Cohoes Indus. Terminal, Inc.),
931 F.2d
64.
222, 228 (2d Cir. 1991) (“Although a
debtor need not be in extremis in order to [T]he drafters of the
file such a petition, it must, at least, face Bankruptcy Code
such financial difficulty that, if it did not understood the need for
file at that time, it could anticipate the need early access to bankruptcy
to file in the future.”); In re Dixie Broad., relief to allow a debtor to
15
rehabilitate its business reorganize under t he
before it is faced with a protection of Chapter 11.
hopeless situation. Such Those courts have
encouragement, however, r e c ogni z e d that if a
does not open the door to petitioner has no need to
premature filing, nor does it rehabilitate or reorganize, its
allow for the filing of a petition cannot serve the
bankruptcy petition that rehabilitative purpose for
l a c k s a v a l i d which Chapter 11 was
reorganizational purpose. designed.
SGL Carbon, 200 F.3d at 163 (footnote SGL
Carbon, 200 F.3d at 166 (citations
om itted); see also, e.g., In re omitted). Accordingly, the absence of a
Johns-Manville Corp.,
36 B.R. 727, 736 solvency requirement recognizes that even
(Bankr. S.D.N.Y. 1984) (“Accordingly, the solvent firms can, at times, suffer from
drafters of the Code envisioned that a financial distress.
Id. at 163 (early access
financially beleaguered debtor with real for solvent debtors designed to preempt “a
debt and real creditors should not be hopeless situation”); In re M arshall, 300
required to wait until the economic B.R. 507, 512-13 (Bankr. C.D. Cal. 2003)
situation is beyond repair in order to file a (“It is not uncommon for debtors to be
reorganization petition.”). Saying that solvent under the balance sheet test, and
there is no insolvency requirement, yet to have severe financial problems. . . .
however, does not mean that all solvent The United States bankruptcy law is
firms should have unfettered access to designed to provide relief from creditor
Chapter 11. Despite the absence of an pressures for debtors with cash flow
express financial eligibility requirement in difficulties, even where they are clearly
the Code,5 SGL Carbon emphatically solvent under a balance sheet test.”).
rejected any such proposition:
Both the Bankruptcy Court and the
Courts, therefore, have District Court concluded that Integrated
c o n s i s t e n t l y d is m is s e d faced financial distress because it “was
Chapter 11 petitions filed by losing a lot of money,” and “was
financially healthy experiencing a dramatic downward spiral”
companies with no need to in September 2001, and that, as a result,
Integrated had gone “out of business.” We
do not see how bankruptcy offers
5 Integrated any relief from this sort of
Integrated unquestionably meets the
distress, which has no relation to any debt
express statutory requirements for
owed by Integrated. That is, we can
eligibility to file a Chapter 11 petition.
identify no value for Integrated’s assets
11 U.S.C. § 109(d); The Bible Speaks, 65
that was threatened outside of bankruptcy
B.R. 415 at 424-25.
16
by the collapse of Integrated’s business $12.6 million in stock in Del Monte Food
model, but that could be preserved or Co., free of restrictions that would
maximized in an orderly liquidation under otherwise have limited its value to $1.6
Chapter 11. Because Integrated’s million; and (2) limiting the landlord’s
“dramatic downward spiral” does not lease termination damages under §
establish that Integrated was suffering from 502(b)(6). Id. at 201 & n.5. The debtor
financial distress, it does not, standing was successful on both fronts. The Del
alone, establish that Integrated’s petition Monte stock was sold at a court-approved
was filed in good faith. auction for $11 million,
id. at 201 n.5, and
the landlord’s lease claim was capped at
Creditors that fear an impending
$100,000, id. at 207.
default may seek to protect their claims,
triggering “the chaotic mix of self-help Critically, the debtor in PPI claimed
repossession and judicial execution to have been insolvent. In addition to the
available at state law” to which the landlord’s claims, the debtor had
Bankruptcy Code provides an alternative. unsecured claims of approximately $54.6
Warren, Bankruptcy Policymaking, 92 million, dwarfing the value of its only
Mich. L. Rev. at 350. The absence of an asset, the Del Monte stock. PPI, 228 B.R.
insolv ency requirement encourages at 343. The landlord in PPI objected to
companies to file for Chapter 11 before these claims because the debt was owed to
they face a financially hopeless situation. insiders of the debtor, namely, the debtor’s
SGL
Carbon, 200 F.3d at 163-64. Yet this parent companies. The landlord argued
is decidedly not the case here. The that these insider claims should be
Bankruptcy C ourt recognize d th e recharacterized as equity interests, which
unquestionable reality that “the debtor would leave the debtor solvent by
simply was not leveraged” and, apart from approximately $11 million (not including
the Landlord’s claim, “had no significant the landlord’s claim).
Id. at 345. This
debt.” JA34-35. The court’s conclusion issue, however, was not raised on appeal,
that “I don’t think the Code makes any and we proceeded on the assumption that
distinction” is legal error. the debtor “owed 50 million in ‘inter-
company debt.’” PPI, 324 F.3d at 200 n.3.
The absence of any financial
Accordingly, PPI stands fo r the
distress facing Integrated distinguishes the
proposition that an insolvent debtor can
two principal cases relied on by the
file under Chapter 11 in order to maximize
Bankruptcy Court and the District Court.
the value of its sole asset to satisfy its
In PPI, an insolvent debtor defaulted on a
creditors, while at the same time availing
lease with approximately $5.86 million in
itself of the landlord cap under §
rent remaining on the lease. 324 F.3d at
502(b)(6).
200-01. The debtor’s Chapter 11 petition
purported to serve two main purposes: (1) We likewise understand In re
liquidating the debtor’s sole asset, namely, Sylmar Plaza, which the Bankruptcy
17
Court considered “almost on all fours with cannot be divorced from the facts of that
the situation before me,” to be a case in case, which reveal that the Bankruptcy
which Chapter 11 was used to maximize Code was used to maximize value for
value for creditors. The debtors in Sylmar creditors as a whole. Moreover, although
Plaza owned a shopping center that was the debtors appear to have come out
subject to a secure loan from the bank. solvent in Symlar Plaza, there is no
The debtors experienced “cash flow indication that they would have come out
problems” and ultimately defaulted on the solvent had the bank’s claim not been
loan. 314 F.3d at 1072-73. Bankruptcy limited, or that solvency was a foregone
allowed the debtor to sell the shopping conclusion when the petition was filed.
center free and clear of the bank’s lien,
In contrast, as noted above and
which sale the Bankruptcy Court found to
detailed below, according to schedules
be in the best interest of the estate and all
filed with the Bankruptcy Court,
of its creditors. Id. at 1073; Supp. App. at
Integrated had $105.4 million in cash and
114 (Order Authorizing Sale of Real
$1.5 million in other assets at the time that
Property Free and Clear of Liens at 4, In re
it filed for bankruptcy, and yet the
Sylmar Plaza, No. LA-99-33188-AA
Landlord’s proof of claim lists the present
(Bankr. C.D. Cal. Nov. 24, 1999)).
discounted value of Integrated’s lease
The bank did not appeal the sale obligations at approximately $26 million.
order. Sylmar Plaza, 314 F.3d at 1073. I n t e g ra t e d’ s s c h e d u l e s a l s o lis t
Instead, the Bank appealed from the miscellaneous liabilities of approximately
confirmation of the debtor’s plan of $430,000. Thus Integrated was highly
reorganization, which took advantage of a solvent and cash rich at the time of the
provision in the Bankruptcy Code to bankruptcy filing. Even if the IPO class
calculate the bank’s claim according to the action claim, which was capped at $25
regular interest rate, rather than the default million with Integrated’s liability limited
interest rate.
Id. In particular, the bank to a $5 million reserve (the balance to be
objected to the fact that “the plan leaves paid by insurance) was listed at its full
the [debtors] solvent while permitting them alleged value, Integrated was still solvent
to avoid paying post-petition interest at the at the time of filing.
default interest rate.”
Id. at 1074.
In light of the foregoing, we
The Ninth Circuit affirmed the conclude that the collapse of Integrated’s
lower court’s finding of good faith, business model does not support a finding
reasoning that (1) insolvency is not a of good faith. Integrated was not suffering
prerequisite to a finding of good faith, and financial distress when it filed its petition,
(2) the fact that a creditor’s contractual and the rulings of the Bankruptcy Court
rights are adversely affected does not by and the District Court to the contrary
itself warrant a bad faith finding. Id. at constitute legal error. The failure of
1074-75. The court’s holding, however, Integrated’s business did not subject the
18
company to any pressure on the value of its that the securities class action did not place
assets that could be reduced or avoided in Integrated in financial distress. When it
an orderly liquidation under Chapter 11. filed its petition, Integrated had assets of
Because Integrated’s economic difficulties nearly $107 million (of which $105
do not establish that Integrated was million was cash). Integrated also had
suffering from financial distress, they do Directors and Officers (“D&O”) insurance
not, standing alone, establish that coverage of $20 million. Although the
Integrated’s petition was filed in good securities class claimed $93 million,
faith. Integrated concedes in its brief that it
“believed that the Securities Claim would
B.
be settled, likely within policy limits [i.e.,
On appeal, Integrated argues that its for less than $20 million].” Appellee’s Br.
petition served a valid bankruptcy purpose at 33. In documents filed with the SEC,
because bankruptcy “provide[d ] a including a proxy statement issued in
framework for the Debtor to resolve the anticipation of a vote on Integrated’s Plan
Securities Class Action.” Appellee’s Br. at of Complete Liquidation and Dissolution
8. In this regard, the Bankruptcy Court under Delaware law, Integrated stated:
made no findings that are entitled to
The company believes that
deference. Instead the Bankruptcy Court
the claims against it are
merely acknowledged that Integrated
without merit and intends to
“offered a number of reasons for the filing
d e fend this lawsuit
of the bankruptcy case,” and that the court
vigorously. While the
“believe[d] there is validity to a number of
outcome of these claims is
those considerations.” (Emphasis added).
currently not determinable,
“[A] number of those considerations”
the Company does not
necessarily is less than all of those
expect that the ultimate
considerations, and the Bankruptcy Court
costs to resolve these claims
did not ide ntify wh ich pa rticular
will have a material adverse
considerations had merit except to stress
effect on the Company’s
that Integrated “was losing a lot of money.”
financial position, results of
Moreover, colloquially at least, stating that
operations or cash flows.
“there is validity to” something is not the
same as saying that something is valid. James G. Regel, Integrated’s CEO,
testified that the above statement was true
Nevertheless, Integrated bore the
when the proxy statement was filed.
burden of demonstrating good faith, and
Integrated offers no argument that
there is no evidence in the record from
circumstances surrounding the securities
which a finding of good faith could be
class action changed between April of
made based on the pending securities class
2002, when the Board resolved to liquidate
action. There is no question, for example,
under state law, and October of that year,
19
when the Board decided to file under At the April 29 hearing, the
Chapter 11. Bankruptcy Court suggested that the
bankruptcy process facilitated the
In the end, Integrated’s predictions
liquidation of the securities class action.
proved accurate. The securities class
First, the Court reasoned that Chapter 11
ultimately voted in favor of a plan of
“effectively reduced the recovery by the
liquidation that capped their claims at $25
securities law claimants by treating them
million. Although the plan does not
like shareholders pursuant to Section
resolve the securities claims, it limits
510(b).” We cannot find any evidence in
Integrated’s liability for the securities class
the record to support a finding that this
action to a $5 million reserve. The
treatment forced the securities class to
securities class action will go forward, but
accept the $25 million limit that the plan
the class has essentially capped its recovery
places on their potential recovery. Nor
at $25 million (the $5 million reserve plus
could counsel for Integrated and the
the $20 million D&O policy). The
OCESH support this finding when it was
inescapable conclusion from the record is
raised at oral argument.
that the securities class action did not
threaten any value of Integrated that Second, the Bankruptcy Court
Chapter 11 seeks to preserve. This case is observed that, “[i]n a non-bankruptcy law
therefore entirely distinguishable from context, the securities law plaintiffs would
cases such as Johns-Manville, where the have had a very strategic advantage,
debtor faced “approximately 16,000 namely so long as there was a possible
lawsuits pending as of the filing date,” with recovery against the corporation, the
the prospect of the “filing of an even more liquidation would be stalled indefinitely.”
staggering number of suits over the course While the causal connection here may be
of 20-30 years,” 36 B.R. at 729, or The more compelling, we fail to see how this
Bible Speaks, where the debtor experienced observation distinguishes the securities
“two types of financial difficulty: a cash class from any other typical creditor, since
flow problem which prevent[ed] it from creditors often have strategic advantages
meeting its current obligations” and a outside of bankruptcy that they lack inside
“staggering” claim that “may well exceed bankruptcy.
the value of the Debtor’s assets” and that
Regardless, neithe r of the
“pose[d] a threat to the Debtor’s continued
B a n k r u p t c y C o u r t ’ s o b se r v a ti o n s
existence,” 65 B.R. at 426. See SGL
establishes that Integrated suffered
Carbon, 200 F.3d at 168-69 (discussing
these cases). 6
would have remained solvent even if the
6
We further note that, given the $105 securities class and the Landlord were to
million in cash held by Integrated and the recover the full value of their claims ($93
$20 million in D&O coverage, Integrated million and $26 million, respectively).
20
financial distress, and neither supports a failed business.” OCESH Br. at 7.
finding that liquidation under Chapter 11 Dissolution, however, is not an objective
offered a reasonable chance of maximizing that can be attained in bankruptcy. Collier
the value available to satisfy all of the on Bankruptcy § 727.01[3] (“After
parties with an interest in Integrated’s liquidation, any dissolution of the
estate. Rather than pursuing a valid corporation or partnership that the parties
bankruptcy purpose, these observations desire must be effectuated under state law,
suggest that Integrated filed for Chapter 11 since the Code does not provide for
in part to gain a litigation advantage over d i s s o lu t i o n o f c o r p o r a t i o n s o r
the securities class, a use of Chapter 11 that partnerships.”). Nor is “distribution,”
we emphatically rejected in SGL Carbon. standing alone, a valid bankruptcy
200 F.3d at 167 (holding that petition was purpose. Instead, the Bankruptcy Code
not filed in good faith where debtor’s sole allows for a distribution of the debtor’s
purpose was “to put pressure on [a estate pursuant to a valid plan of
claimant] to accept the company's reorganization or liquidation. 11 U.S.C. §
settlement terms”). 1123. Antecedent to any such distribution
is an inquiry whether the petition and the
C.
plan are filed in good faith, i.e., whether
Integrated argues that its petition they serve a valid bankruptcy purpose.
served three additional purposes that Neither Integrated nor the OCESH offer
support a finding of good faith. As with any authority that the Code can be used to
the securities class action, the Bankruptcy effectuate a liquidation that has no hope of
Court did not specify which, if any, of maximizing the value of the company, 203
these asserted justifications had merit. Our N. LaSalle, 526 U.S. at 453; Toibb, 501
own review of the record convinces us that U.S. at 163, but simply facilitates
none of Integrated’s proffered justifications dissolution on terms favorable to equity
warrant a finding of good faith. interests. Moreover, neither Integrated nor
the OCESH have identified any
First, Integrated argues that Chapter
efficiencies that were realized in this
11 “provide[d] an efficient procedure for
bankruptcy that could not have been
the dissolution of Debtor and distribution
realized under Delaware law.
of its assets to parties in interest.”
Appellee’s Br. at 8. In the same vein, the Second, Integrated argues that
OCESH argues that “[t]he Debtor’s Chapter 11 “provide[d] court oversight to
Chapter 11 filing was in good faith the proposed sale of its intellectual
[because] the debtor utilized the liquidation property [as well as] certain protections to
provisions under Chapter 11 of the the parties [to the sale] not available
Bankruptcy Code for the proper purpose of outside of Chapter 11.” Appellee’s Br. at
obtaining a quick, efficient, and orderly 8. Integrated’s intellectual property assets
winding down of the operations of its consist of patents, trademarks, copyrights,
21
and trade secrets related to the company’s and, but for Integrated’s petition, the
products and services. There is no dispute OCESH would not have existed. But
that the sale of these assets during the surely Integrated did not need Chapter 11
bankruptcy realized an additional $1 to discover that a more open and
million beyond the sale that Integrated had competitive auction might increase the
negotiated prior to filing its Chapter 11 price obtained for its assets.
petition. Under the circumstances of this
Moreover, the increase in value was
case, however, this fact hardly justifies
relatively insignificant, representing less
invocation of Chapter 11.
than one percent of Integrated’s total
For one, the increase in value was a assets. Integrated’s de minimis assets
result of Integrated’s failure to adequately (office equipment, inventory, etc.), by
market the assets to potential bidders comparison, totaled $500,000. Further, the
outside of the Board and management. 7 net gain to Integrated’s estate must also
When, on the very next day after it filed its consider the fees paid from the estate to
petition, Integrated moved to sell the assets the OCESH’s committee mem bers,
at auction without further marketing, the attorneys, and professionals. In the end,
OCESH challenged Integrated’s sale as an this case is a far cry from PPI, where an
improper exercise of business judgment. insolvent debtor used Chapter 11 to
True, the OCESH is “a creature of the increase the value of its sole asset by over
Bankruptcy Code,” Appellee’s Br. at 31, 600 percent ($1.6 million to $11 million).
That bankruptcy allowed for an additional
$10 million to be paid to the creditors of
7
Although Integrated suggests that the the debtors. PPI, 324 F.3d at 201 & n.5.
increase in value was realized because
Finally, Integrated argues that
“the Bankruptcy Code afforded Debtor
Chapter 11 “enable[d] the Debtor to
and the buyer protections including the
establish a bar date and define the universe
ability to sell free and clear of liens and
of claims against it to assure that any
claims, see section 363(f), and specific
distributions to its creditors and
evidentiary ‘good faith purchaser’
stockholders account for any inchoate
findings, see section 363(m),” Appellee’s
claims.” Appellee’s Br. at 8. Essentially,
Br. at 30, the record provides no support
Integrated argues that, through the
for this assertion. For the most part, the
OCESH, shareholders were able to
assets were sold to the same insiders with
investigate potential claims and determine
whom Integrated had already negotiated a
that none existed. The Bankruptcy Court
sale prior to filing for Bankruptcy. The
made no finding that Integrated was
fact that these insiders were willing to
subject to “inchoate” claims that needed to
purchase the assets outside of bankruptcy
be liquidated or barred, and Integrated’s
undercuts any argument that the
vague and passing references to potential
protections of the Code affected the
disputes with its shareholders is entirely
purchase price.
22
insufficient to establish a good faith declare it?”).
expectation that Chapter 11 protection was
The far more relevant question is
necessary to protect Integrated from such
whether a desire to take advantage of a
claims.
particular provision in the Bankruptcy
D. Code, standing alone, establishes good
faith.8 We hold that it does not. Just as a
Having determined that Integrated
desire to take advantage of the protections
was not in financial distress, and having
of the Code cannot establish bad faith as a
r e j e ct e d I n t e g r a t e d ’ s p o s t h o c
matter of law, that desire cannot establish
rationalizations for filing under Chapter 11,
good faith as a matter of law. Given the
we turn to the OCESH’s argument that
truism that every bankruptcy petition seeks
Integrated’s desire to take advantage of the
some advantage offered in the Code, any
cap on landlord claims provided by §
other rule would eviscerate any limitation
502(b)(6) establishes good faith in and of
that the good faith requirement places on
itself. Integrated makes a similar argument
Chapter 11 filings.
when it states that its petition properly
sought “a favorable forum for the At least one Bankruptcy Court has
consideration and resolution of other dismissed for a lack of good faith a
disputed claims, including the Landlord’s Chapter 11 petition seeking primarily to
claim.” Appellee’s Br. at 8. cap a landlord’s claim for future rent under
§ 502(b)(6), In re Liberate Technologies,
The Bankruptcy Court did not hold
No. 04-31394-TC, 2004 WL 2008956, at
that Integrated’s desire to take advantage
*7-*8 (Bankr. N.D. Cal. Sept. 8, 2004),
of the § 502(b)(6) cap established good
and other Bankruptcy Courts have
faith. Instead, the Bankruptcy Court held
similarly dismissed Chapter 11 petitions
that “it does not establish bad faith for a
filed merely to take advantage of other
debtor to file a chapter [11] case for the
purpose of taking advantage of provisions
which alter pre-petition rights, including
8
altering the rights of a landlord under State The law is clear that the burden is on
law.” (Emphasis added). We agree. the bankruptcy petitioner to establish that
Indeed, we believe it to be a truism that it its petition has been filed in good faith.
is not bad faith to seek to avail oneself of a PPI, 324 F.3d at 211; SGL Carbon, 200
particular protection in the Bankruptcy F.3d at 162 n.10. The Bankruptcy
Code— Congress enacted such protections Court’s statements that “it does not
with the expectation that they would be establish bad faith for a debtor to,” or “I
used. In re James Wilson Assocs., 965 conclude that as a matter of law, that is
F.2d 160, 170 (7th Cir. 1992) (“It is not not a debilitating fact,” erroneously
bad faith to seek to gain an advantage from suggest that the question before the court
declaring bankruptcy—why else would one was whether bad faith, rather than good
faith, had been proven.
23
singular provisions of the Bankruptcy In re HBA East, Inc., 87 B.R. 248, 262
Code. See N.W. Place, Ltd. v. Cooper (In (Bankr. E.D.N.Y. 1988). Indeed, if there
re N.W. Place, Ltd.),
73 B.R. 978, 982 is a “classic” bad faith petition, it may be
(Bankr. N.D. Ga. 1987) (Chapter 11 one in which the petitioner’s only goal is
petition filed to invoke trustee’s avoidance to use the automatic stay provision to
powers under Bankruptcy Code and to set avoid posting an appeal bond in another
aside transfer); In re S. Cal. Sound Sys., court. E.g.,
Marsch, 36 F.3d at 828.
Inc.,
69 B.R. 893, 900 (Bankr. S.D. Cal.
Integrated and the OCESH may
1987) (Chapter 11 petition filed to reject
therefore be correct that § 502(b)(6)
executory contract pursuant to 11 U.S.C. §
reflects a Congressional determination that
365(a)); In re Cardi Ventures, Inc., 59 B.R.
landlords stand to receive a windfall in a
18, 22-23 (Bankr. S.D.N.Y. 1985) (Chapter
bankruptcy, and that landlord claims are
11 petition filed to assume and assign lease
inherently speculative. Furthermore,
pursuant to 11 U.S.C. § 365(f)); In re
Integrated and the OCESH may be correct
Nancant, Inc., 8 B.R. 1005, 1008 (Bankr.
that § 502(b)(6) should operate to cap
D. Mass. 1981) (Chapter 11 petition filed
landlord claims, even where the only effect
to have certain tax liability determined
of the cap would be to transfer assets from
pursuant to 11 U.S.C. § 505). For
creditors to equity holders.9 Yet §
example, 11 U.S.C. § 362 protects debtors
502(b)(6) and the legislative policy
by staying litigation against them during
underlying that provision assume the
the pendency of the bankruptcy. Yet courts
existence of a valid bankruptcy, which, in
universally demand more of Chapter 11
turn, assumes a debtor in financial distress.
petitions than a naked desire to stay
The question of good faith is therefore
pending litigation. E.g., Dixie Broad., 871
antecedent to the operation of § 502(b)(6).
F.2d at 1026-27. As one Bankruptcy Court
put it: Although the Bankruptcy Code
contains many provisions that have the
The protection of the
effect of redistributing value from one
automatic stay is not per se a
interest group to an other, these
valid justification for a
redistributions are not the Code’s purpose.
Chapter 11 filing; rather, it is
Instead, the purposes of the Code are to
a consequential benefit of an
preserve going concerns and to maximize
otherwise good faith filing.
the value of the debtor’s estate. 203 N.
A perceived need for the
LaSalle, 526 U.S. at 453; Toibb, 501 U.S.
autom atic stay, without
at 163-64. Section 502(b)(6) is precisely
more, cannot convert a bad
faith filing to a good faith
one.
9
The Landlord and Amici vigorously
argue that § 502(b)(6) does not apply to a
solvent debtor.
24
the sort of provision this Court had in mind Elizabeth Warren, Bankruptcy Policy, 54
when we stated: U. Chi. L. Rev. 775, 792 (1987), for the
proposition that “[a]n almost axiomatic
It is easy to see why courts
principle of business law is that, because
have required Chapter 11
equity owners stand to gain the most when
petitioners to act within the
a business succeeds, they should absorb
scope of the bankruptcy laws
the costs of the business’s collapse—up to
to further a valid
the full amount of their investment”); see
reorganizational purpose.
also 203 N. LaSalle, 526 U.S. at 453
Chapter 11 vests petitioners
(characterizing one of the purposes of
with considerable
Chapter 11 as “maximizing property
powers—the automatic stay,
available to satisfy creditors”).
the exclu sive right to
propose a reorganization As we have explained above, in a
plan, the discharge of debts, smoking gun resolution approved by the
etc.— that can impose Board, and notwithstanding its strong
significant hardship on financial position, Integrated authorized a
particular creditors. When letter to the Landlord threatening that if it
financially troub led did not enter into a settlement of the lease
petitioners seek a chance to in the amount of at least $8 million,
remain in business, the Integrated would file for bankruptcy so as
exercise of those powers is to take advantage of § 502(b)(6), which
justified. But this is not so sharply limits the amount that a landlord
when a petitioner’s aims lie can recover in bankruptcy for damages
o u t s id e t h ose of th e resulting from the termination of a lease.
Bankruptcy Code.
Taken to its logical conclusion, the
SGL Carbon, 200 F.3d at 165 (emphasis OCESH’s argument is that any entity
added). To be filed in good faith, a petition willing to undergo Chapter 11 proceedings
must do more than merely invoke some may cap the claims of its landlord.
d i s tr i b u ti o n a l m e c h anism in th e Nothing in the Bankruptcy Code or its
Bankruptcy Code. It must seek to create or legislative history suggests that §
preserve some value that would otherwise 502(b)(6) was meant to allow tenants to
be lost—not merely distributed to a avoid their leases whenever the landlord’s
d i f f e r en t s t a k e ho l d e r — o u t s i d e of state law remedy exceeds the cap under §
bankruptcy. This threshold inquiry is 502(b)(6) by an amount greater than the
particularly sensitive where, as here, the cost of proceeding through a Chapter 11
petition seeks to distribute value directly reorganization or liquidation. Such a rule
from a creditor to a company’s would not only obviate the need for a good
shareholders. See In re Telegroup Inc., faith requirem ent, b ut would be
281 F.3d 133, 140 (3d Cir. 2002) (quoting antithetical to the structure and purposes of
25
the Bankruptcy Code.
III.
We hold that both the District Court
and the Bankruptcy Court erred as a matter
of law in concluding that Integrated
suffered financial distress. Although
Integrated’s business model had failed, the
company had no significant debt apart from
the Landlord’s claim. Moreover, the
record demonstrates that the securities
class action did not present a significant
threat to Integrated’s finances. Because
Integrated was not in financial distress, its
Chapter 11 petition was not filed in good
faith as it cou ld no t— and did
not—preserve any value for Integrated’s
creditors that would have been lost outside
of bankruptcy. We will therefore reverse
the order of the District Court affirming the
Bankruptcy Court’s denial of the
Landlord’s motion to dismiss, and will
remand this case to the Bankruptcy Court
with instructions to dismiss Integrated’s
petition.
26
