Bankruptcy Code § 707(a) provides that a chapter 7 case may be dismissed “for cause,” including for (1) unreasonable delay, (2) nonpayment of fees or (3) failure to timely file certain information. However, “cause” is not defined, and the statutory examples are illustrative, not exhaustive. Currently, there is a circuit split as to whether bad faith can be “cause.”
In 1991, the Sixth Circuit recognized that bad faith can support § 707(a) dismissal.[1] Today, a majority of circuits agree. The Third Circuit permits § 707(a) dismissal for bad faith, instructing that courts “determine good faith only on an ad hoc basis and must decide whether the petitioner has abused the provisions, purpose, or spirit of bankruptcy law,” with the understanding that bad faith “should not [be] lightly infer[red].”[2] The Fifth Circuit recognizes that a debtor’s pre- and post-petition behavior can support § 707(a) dismissal for bad faith, even if other Code provisions arguably encompass the conduct.[3] The Eleventh Circuit has held that bad faith may constitute “cause” under § 707(a), and applies a totality-of-the-circumstances approach.[4] The Second Circuit has not yet addressed the issue; however, a bankruptcy court in that circuit has indicated that if dismissal for bad faith is permitted, a “stringent standard” is proper.[5] By contrast, the Ninth Circuit has held that while “bad faith per se can properly constitute ‘cause’ for dismissal of a Chapter 11 or Chapter 13 petition,” as a general proposition it cannot constitute “cause” for dismissal of a chapter 7 petition under § 707(a).[6] The Eighth Circuit has held that while some conduct giving rise to dismissal under § 707(a) can be characterized as bad faith, the inquiry is properly whether the petition should be dismissed “for cause.”[7]
Recently, in Janvey v. Romero,[8] the Fourth Circuit joined the majority circuits, reasoning that “the majority view is the sounder one, because it is the most helpful in preventing serious abuses of the bankruptcy process.”[9] However, the court stressed that bad faith is reserved for cases of “real” misconduct,[10] echoing other majority-position circuits.
In Janvey, the debtor had been a retired foreign service officer who founded a consulting business. When it came to light that Stanford Financial Group, one of the debtor’s clients, ran a Ponzi scheme, the debtor cuts ties with Stanford. However, the SEC sued Stanford in U.S. district court, and the receiver, Ralph Janvey, sued the debtor, seeking to recover for the Ponzi victims. Pre-trial, the debtor offered to settle, but Janvey rejected the offer and declined to counteroffer. While appealing the $1.25 million judgment against him, the debtor again offered to settle — which Janvey rejected without counteroffering.
After the debtor lost his appeal, he filed for chapter 7 relief. He had $5.35 million in mostly exempt assets, and had debts of the $1.25 million judgment and $150,000 in legal bills. His monthly expenses exceeded his income by $350, due to medical expenses for his disabled wife.
Janvey moved to dismiss under § 707(a), alleging bad faith. The bankruptcy court held that while bad faith may constitute § 707(a) “cause,” the debtor had not acted in bad faith.[11] The court noted that while the debtor’s primary motivation in filing was to avoid paying the judgment, it was not his only motivation.[12] The debtor could not earn a living, had high medical costs, faced termination of insurance policies, and had large legal bills from Janvey’s aggressive litigation tactics — and while the debtor lived comfortably, his lifestyle was not exorbitant.[13]
Janvey appealed to the U.S. district court, which affirmed. He further appealed to the Fourth Circuit. The Fourth Circuit agreed with the majority circuits that bad faith may constitute § 707(a) “cause,”[14] then turned to determining whether the bankruptcy court erred in concluding that bad faith had not been established.
The Fourth Circuit employed a totality-of-the-circumstances approach and considered public policy concerns. First, it rejected Janvey’s argument that bad faith had been established because the debtor sought to discharge only a single debt. The court observed that not only was Janvey’s “single debt” allegation untrue (the judgment debt, in fact, had not been the debtor’s only debt), but Janvey’s legal contention was flawed.[15] According to the Fourth Circuit, bad faith cannot be established merely because the debtor has only one debt to discharge. While a court may consider, among other facts, the fact that the debtor has only one debt to discharge, it is not proper to “transform this single factor into a per se test for bad faith.”[16] Second, the Fourth Circuit called “groundless”[17] Janvey’s argument that the debtor committed “blackmail” by raising the possibility of bankruptcy during settlement efforts.[18] Third, the court rejected Janvey’s argument that the debtor had “too much money,” essentially complaining that the debtor was not forced to use exempt assets. The Fourth Circuit called this argument contrary to bankruptcy policy (“[a] penniless start is not a fresh start”[19]) and public policy (“[w]ere absolute depletion of one’s assets a prerequisite for bankruptcy relief, debtors and their families would be left destitute and without means to become productive members of society”[20]).
Although the Janvey debtor did not act in bad faith, Janvey does not suggest shelter for debtors who have. Debtors should be informed of the expanding acceptance of bad faith as a ground for dismissal and be advised of what may constitute bad faith. Janvey also reiterates that dismissal for bad faith requires egregious facts, in the totality of the circumstances. Filing for bankruptcy to avoid a judgment debt, without more, likely is not egregious. Moreover, creditors should consider the risks involved when using aggressive litigation tactics with potential debtors. If a creditor pushes a judgment-debtor into bankruptcy, collectability may be the ultimate price.
[1] In re Zick, 931 F.2d 1124, 1126-27 (6th Cir. 1991).
[2] In re Tamecki, 229 F.3d 205, 207 (3d Cir. 2000).
[3] In re Krueger, 812 F.3d 365, 372 (5th Cir. 2016). The Fifth Circuit commented: “This appeal ... can only be described as an exercise in chutzpah.... The bankruptcy and district courts finally had enough of [the debtor’s] manipulation and rightly dismissed pursuant to ...§ 707(a) for the debtor’s bad faith conduct....” Id. at 366-67.
[4] In re Piazza, 719 F.3d 1253, 1271-72 (11th Cir. 2013) (declining to adopt 15-factor list utilized by bankruptcy court, but determining that bankruptcy court properly examined facts).
[5] In re Chovev, 559 B.R. 339, 347 (Bank. E.D.N.Y. 2016).
[6] In re Padilla, 222 F.3d 1184, 1193 (9th Cir. 2000).
[7] In re Huckfeldt, 39 F.3d 829, 832 (8th Cir. 1994).
[8] 883 F.3d 406 (4th Cir. 2018).
[9] Id. at 412.
[10] Id.
[11] In re Romero, 557 B.R. 875, 881-84 (Bankr. D. Md. 2016) (applying the bad-faith test set forth in McDow v. Smith, 295 B.R. 69 (E.D. Va. 2003)).
[12] Id. at 883.
[13] Id.
[14] 883 F.3d at 412.
[15] Id. at 414-15.
[16] Id. at 415.
[17] Id.
[18] Id. at 416.
[19] Id.
[20] Id.