Solvent Debtors and Good Faith

Journal Issue

Mar 2005

Column Name

On the Edge

Bankruptcy Code

502

Topic Tags

Discharge/Dischargeability

Ethics

Journal HTML Content

Last year, the Third Circuit Court of
Appeals in the case of In re Integrated Telecom Express Inc., 384
F.3d 108 (3d. Cir. 2004), reinvigorated the debate on whether a
bankruptcy petition filed by a solvent debtor can be dismissed because
it is not filed in good faith.<a href="#1" name="1a">1</a> Indeed, as a result of these decisions,
one columnist posed the question of "when can a solvent debtor file in
'good faith?'" Keach, "Solvent Debtors and Myths of Good Faith and
Fiduciary Duty," 23 ABI Journal 36 (January 2005). In a decision
from early 2005 that was unpublished as of the deadline for submitting
this article, the court from the Northern District of Texas provides
some answers. See In re Mirant Corp., et. al., Case No. 03-46590,
Memorandum Opinion and Order, Docket No. 8060 (Bankr. N.D. Tex. Jan. 26,
2005).

<h4>Questions of Good Faith</h4>

In the Integrated Telecom case, a solvent debtor filed for
bankruptcy for the principal purpose of taking advantage of the
Bankruptcy Code's cap on liability to landlords in 11 U.S.C.
§502(b)(6).<a href="#2" name="2a">2</a>
Pursuant to its strategy, the debtor in Integrated Technologies
was seeking to reduce its liability to its landlord by approximately $21
million.<a href="#3" name="3a">3</a> In other
words, the debtor was effectively seeking to increase the distributions
to its equity-holders by approximately $21 million.

The landlord filed a motion to dismiss Integrated Technologies's
bankruptcy petition as not being filed in good faith. The bankruptcy
court denied the landlord's motion. On appeal, the district court
affirmed the bankruptcy court. But on further appeal, the Third Circuit
reversed. While the Third Circuit noted that a debtor need not be
insolvent to file for bankruptcy, it held that not all solvent firms
should have "unfettered" use of the bankruptcy process.<a href="#4" name="4a">4</a> The court reasoned that in order
for the petition to have been filed in good faith, the purpose of the
bankruptcy must be to create or preserve some value for the benefit of
stakeholders, not merely seek to distribute value to a stakeholder who
would have received less outside of bankruptcy.<a href="#5" name="5a">5</a> The Third Circuit concluded that since
Integrated Technologies was not suffering financial distress, and its
purpose in filing for bankruptcy was to limit its liability to a
creditor for the benefit of equity, the petition was not filed in good
faith, and the bankruptcy case should be dismissed.<a href="#6" name="6a">6</a>

<h4>Solvent Debtors Revisited</h4>

The facts in the Mirant case are more complicated than those
in Integrated Technologies. In Mirant, the issue related
to the motion to dismiss the case of one of more than 80 related
debtors.<a href="#7" name="7a">7</a> The

Mirant debtors are in the business of owning and operating power
plants, and marketing the electricity that is generated. The debtor at
issue in the Mirant decision is Mirant Mid-Atlantic LLC (MirMA).

In 2000, MirMA was formed to facilitate the acquisition of certain
power-generating assets by Mirant. Pursuant to a series of transactions,
MirMA purchased, sold and then leased two power plants.<a href="#8" name="8a">8</a> The principal creditors of MirMA
are its landlords, though MirMA also has limited other debt. MirMA's
landlords (and others) filed motions to dismiss MirMA's bankruptcy
petition as not being filed in good faith.

The court addressed three questions: (1) are there two standards for
good-faith filings, one for a single debtor and another for a corporate
family; (2) was the MirMA case filed in good faith and (3) if the case
was not filed in good faith, should the court otherwise deny the motion
because of undue risk to MirMA and other parties?<a href="#9" name="9a">9</a>

The court initially held that the standard applied to good-faith
dismissal of a single debtor is different than the standard applied to
"a key operating affiliate placed in chapter 11 in conjunction with
necessary filings by its family of affiliates."<a href="#10" name="10a">10</a> The court noted that if MirMA had not
been included in the bankruptcy filing, MirMA would likely have been
subject to repercussions from the filings by the
affiliates.<a href="#11" name="11a">11</a>

Since the whole corporate enterprise needed rehabilitation, the court
found that MirMA met the good-faith requirement under the corporate
family test.<a href="#12" name="12a">12</a>

The court next examined the MirMA filing under the "valid bankruptcy
test" to determine good faith.<a href="#13" name="13a">13</a> Under this test, a bankruptcy filing is
in good faith if it is filed to preserve the going concern and maximize
value for the benefit of creditors.<a href="#14" name="14a">14</a> The court found that under its
agreements with its landlords and others, MirMA would be in default as a
result of the bankruptcy petitions filed by its affiliates and MirMA's
management was concerned as to what would happen to it when it was in
default.<a href="#15" name="15a">15</a> The
court found that management's concerns were a valid reason for filing
for bankruptcy.<a href="#16" name="16a">16</a>

A variation of the valid bankruptcy purpose test is an examination of
the filing to make certain it was not filed for nefarious
reasons.<a href="#17" name="17a">17</a> The
movants alleged that MirMA's motive in filing for bankruptcy was to
initiate litigation to recharacterize leases as secured
debt.<a href="#18" name="18a">18</a> The court
examined the evidence and concluded that MirMA's management did not have
improper motives.<a href="#19" name="19a">19</a>

Finally, the court assumed that the debtor failed to meet the
good-faith test and examined the question of whether it should still
decline to dismiss the case.<a href="#20" name="20a">20</a> The court concluded it would not dismiss
the case. The court's reasons were (1) MirMA would be put at undue risk
because it was in technical default under numerous agreements, and (2)
affiliated debtors would be put at undue risk because MirMA was a
borrower on the DIP loan, and dismissal of the MirMA case would
constitute a default on the DIP loan.<a href="#21" name="21a">21</a> Thus, since the dismissal would
potentially cause harm to MirMA and its affiliates, the court denied the
motion to dismiss.<a href="#22" name="22a">22</a>

<h4>Appeal to Follow</h4>

The movants in Mirant have filed a motion to appeal the
bankruptcy court's decision. Consequently, this may not be the last word
from Mirant. However, the opinion does show that courts will not
necessarily dismiss the bankruptcy petitions of solvent debtors.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> See Keach, Robert,
"Solvent Debtors and Myths of Good Faith and Fiduciary Duty," 23 ABI
Journal, 36 (January 2005); Bowles, C.R. Jr., 23 ABI Journal,

22 (November 2004); Seife, Howard, "Solvent Debtors May Be Unable to
Enter Bankruptcy in Absence of 'Financial Debtors,'" 122 Banking
L.J. 52 (January 2005); Scheckter, Don, "Third Circuit Holds that
Solvent Debtors' Chapter 11 Petition Is in Bad Faith when Petition Is
Filed to Invoke Rent Cap," 2004 Comm F. News 70 (October 2004).
The 2005 Annual Spring Meeting will hold a debate on this subject. <a href="#1a">Return to article</a>

<a name="2">2</a> See 384 F.3d at
127. <a href="#2a">Return to article</a>

<a name="3">3</a> See 384 F.3d at
116. <a href="#3a">Return to article</a>

<a name="4">4</a> See 384 F.3d at
121. <a href="#4a">Return to article</a>

<a name="5">5</a> See 384 F.3d at
129. <a href="#5a">Return to article</a>

<a name="6">6</a> See 384 F.3d at
129. <a href="#6a">Return to article</a>

<a name="7">7</a> See Mirant, p.1
and p. 6. <a href="#7a">Return to article</a>

<a name="8">8</a> See Mirant, p. 3.
<a href="#8a">Return to article</a>

<a name="9">9</a> See Mirant, p. 10.
<a href="#9a">Return to article</a>

<a name="10">10</a> See Mirant, p.
12 citing Heisley v. U.I.P. Engineered Prods. Corp. (In re
U.I.P. Engineered Prods. Corp.), 831 F.2d 54 (4th Cir. 1987). <a href="#10a">Return to article</a>

<a name="11">11</a> See Mirant, p.
13. <a href="#11a">Return to article</a>

<a name="12">12</a> See Mirant, p.
13. <a href="#12a">Return to article</a>

<a name="13">13</a> See Mirant, p.
14. The court initially noted that several courts set out factors to
consider in the good-faith analysis. See, e.g., Little Creek Dev. Co.
v. Commonwealth Mortgage Corp. (In re Little Creek), Denver,
779 F.2d 1068, 1073 (5th Cir. 1986) (The debtor has one asset, the
secured creditor's liens encumber the asset, the debtor has no
employees, the debtor has little or no cash flow, etc.). The court
concluded that these cases were not suitable in evaluating MirMA's good
faith. <a href="#13a">Return to article</a>

<a name="14">14</a> See Mirant, p.
14. (quoting from Integrated Telecom). <a href="#14a">Return to
article</a>

<a name="15">15</a> See Mirant, p.
14. <a href="#15a">Return to article</a>

<a name="16">16</a> See Mirant, p.
16-17. <a href="#16a">Return to article</a>

<a name="17">17</a> See Mirant, p.
18. <a href="#17a">Return to article</a>

<a name="18">18</a> See Mirant, p.
19. <a href="#18a">Return to article</a>

<a name="19">19</a> See Mirant, p.
19-20. <a href="#19a">Return to article</a>

<a name="20">20</a> See Mirant, p.
22. <a href="#20a">Return to article</a>

<a name="21">21</a> See Mirant, p.
23-24. <a href="#21a">Return to article</a>

<a name="22">22</a> See Mirant, p.
23-24. <a href="#22a">Return to article</a>

Journal Authors

Gregory G. Hesse

Journal Date