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Delaware Bankruptcy Court Dismisses Chapter 11 Petitions for Failing to Meet Good Faith Standard

In its opinion dated February 13, 2018, the Delaware Bankruptcy Court dismissed the chapter 11 cases of Rent-A-Wreck of America, Inc. and its subsidiary Bundy American, LLC (collectively, the "Debtors").  The opinion written by Judge Silverstein concluded that the chapter 11 petitions were not filed in good faith in accordance with section 1112(b) of the Bankruptcy Code.

The Court, in ruling in favor of dismissal, looked to the Third Circuit Court of Appeals decision of SGL Carbon Corp., 200 F.3d 154 (3d Cir. 1999) when reviewing the facts at hand.  The Third Circuit decision of SGL Carbon held that section 1112(b) of the Bankruptcy Code imposes a good faith standard.  The Bankruptcy Court noted that bankruptcy courts patrol the line between "accomplishing the objectives of rehabilitation and reorganization, and the use of these statutory provisions to destroy and undermine the legitimate rights and interests of those intending to benefit by this statutory policy." Op. at 13, quoting SGL Carbon, at 161.

While there is no definitive list of factors determination of deciding good faith, the Court looked to the Third Circuit's focus on two particularly relevant inquiries:  "(1) whether the petition serves a valid bankruptcy purposes, e.g., by preserving a going concern or maximizing the value of the debtor's estate, and (2) whether the petition is filed to obtain a tactical advantage."  Op. at 14, quoting In re Integrated Telecom Express, Inc., 384 F.3d 108, 119-20 (3d Cir. 2004)(citing SGL Carbon, 200 F.3d at 162).  The Court noted that while the desire to use provisions of the Bankruptcy Code to one's advantage does not constitute a bad faith filing, it also does not constitute a good faith filing.  Id. at 15.  The ability to use the distributive provisions of the Code assumes existence of a valid bankruptcy, "which, in turn, assumes a debtor in financial distress."  Id. quoting Integrated Telecom, at 128.  The Court concluded that the Debtors had to prove by a preponderance of the evidence that their cases were filed in good faith, including that they were in financial distress.

The Court found that the record failed to show that the Debtors were in financial distress when they filed the bankruptcy petitions.  The Debtors believed that they only needed to show that they had a valid reorganizational purpose.  The record showed that insolvency played no part in the bankruptcy filings.  There was no record of the Debtors feeling pressure of creditors for payment (i.e., a "race to the courthouse") or that the Debtors were failing to pay debts as they came due.  The audited financials showed a positive cash flow from operating activities and positive year end cash.

The Court found that the primary purpose of the bankruptcy filings was to reject a franchise agreement so the Debtors could open their territorial operations in the Los Angeles area to multiple royalty paying franchisees.  The Court's inquiry was "particularly sensitive" to a petition that "seeks to distribute value directly from a creditor to a company's shareholders."  Op. at 28 quoting Integrated Telecom, at 129.  The filings did not create (or preserve value) that would be lost outside of bankruptcy.  Although these cases were not a classic "two party" dispute, they had a sense of one.  Based on the totality of the circumstances, the Court concluded that the cases were not filed in good faith.