Lack of Financial Distress Doesn’t Divest a Court of Subject Matter Jurisdiction

In the space of two months, two different bankruptcy judges in North Carolina have ruled that a lack of financial distress does not require the dismissal of a chapter 11 case on constitutional grounds.

At the end of December, Bankruptcy Judge J. Craig Whitley of Charlotte, N.C., denied a motion to dismiss a pair of “asbestos” chapter 11 cases by holding that (1) the lack of “financial distress” does not divest the court of subject matter jurisdiction, and (2) there is no violation of the Bankruptcy Clause of the Constitution when the debtor has no “financial distress.” In re Aldrich Pump LLC, 20-30608, 2023 WL 9016506 (Bankr. W.D.N.C. Dec. 28, 2023). To read ABI’s report, click here.

In short order, Judge Whitley found “no provisions in the Bankruptcy Code evidencing a congressional intent to impose a jurisdictional insolvency or ‘financial distress’ requirement to file bankruptcy.” He held that the movants’ constitutional challenges were “not challenges to the Court’s subject matter jurisdiction.”

In a 59-page opinion on February 21, Bankruptcy Judge Laura T. Beyer, also of Charlotte, devoted most of her merits discussion to explaining in detail why the lack of financial distress does not deprive the bankruptcy court of subject matter jurisdiction. We recommend reading the opinion in full text to appreciate the wealth of historical detail underpinning Judge Beyer’s conclusions.

The Georgia-Pacific Two-Step

Judge Beyer said that the debtor’s prefiling history “was unusual and unusually brief.”

In 1965, Georgia-Pacific merged with Bestwall Gypsum, whose asbestos-laden products resulted in thousands of lawsuits. GP underwent a Texas divisional merger in 2017 where “old” GP ceased to exist. Two companies arose.

Bestwall became solely responsible for mass tort liability. The second new company, which we shall refer to as New GP, received all of the assets of “old” GP but was not responsible for any asbestos liability.

To account for the paucity of assets, Bestwall was given a funding agreement from New GP enabling it to pay asbestos liabilities, either in bankruptcy or outside of bankruptcy. Soon after the filing, the bankruptcy court entered a preliminary injunction barring lawsuits against nondebtors.

Twice before in the case, Judge Beyer denied dismissal motions by the official creditors’ committee. Significantly, they remain on appeal. However, the Fourth Circuit upheld the preliminary injunction last year, finding “related to” jurisdiction in the process. Official Committee of Asbestos Claimants v. Bestwall LLC (In re Bestwall LLC), 71 F.4th 168 (4th Cir. June 20, 2023). To read ABI’s report, click here.

The New Motions to Dismiss

An individual creditor and the official committee filed what amounted to the third and fourth motions to dismiss.

The individual creditor wanted Judge Beyer to find a lack of good faith given the debtor’s absence of financial distress. The creditor was relying in large part on In re LTL Management LLC, 58 F.4th 738, 64 F.4th 84 (3d Cir. Jan. 30, 2023), where the Third Circuit dismissed the chapter 11 case of a Johnson & Johnson subsidiary for lack of “financial distress.” To read ABI’s report on LTL, click here.

Judge Beyer denied the individual creditor’s motion on two grounds: (1) the law of the case precluded her from revisiting her prior dismissal opinions where she found no lack of good faith, and (2) she had no power to revisit good faith because the issue remains on appeal.

The official committee, however, wanted Judge Beyer to rule there was no subject matter jurisdiction, again given the lack of financial distress. Despite the pending appeal, Judge Beyer decided that she could rule because lack of subject matter jurisdiction may be raised at any stage of the case.

History and Practical Considerations

Judge Beyer described the committee’s motion as advancing a “nuanced argument … that the court does not have constitutional subject matter jurisdiction to hear this case due to the Debtor’s lack of financial distress.” Responding, she surveyed U.S. and English bankruptcy law from the eighteenth century to the present and said:

While the language of the Bankruptcy Clause, the history of American bankruptcy law, and the Supreme Court’s descriptions of the bankruptcy power do not definitively answer, or even directly address, the question of whether constitutional subject matter jurisdiction requires a debtor in financial distress, the absence of support for the Committee’s argument is conspicuous. There are simply no cases at any level (of which this court is aware) that explicitly endorse the proposition that bankruptcy courts do not have subject matter jurisdiction unless a debtor has a sufficient degree of financial distress.

In fact, Judge Beyer cited the Third Circuit for holding in LRL that the bankruptcy court had subject matter jurisdiction. LTL, supra, 58 F.4th at 99.

Judge Beyer identified practical problems were financial distress a jurisdictional requirement. For instance, “a financial distress requirement for subject matter jurisdiction is the tension with the goal of getting potential debtors to commence their cases early.”

If financial distress were necessary for filing, Judge Beyer said that Congress “likely” would have added the requirement in Section 109. She saw “no need for a harsh new jurisdictional rule because there are other ways for courts to address any perceived abuse by debtors lacking financial distress,” listing dismissal for lack of good faith and the court’s ability to lift the automatic stay.

Judge Beyer held “that financial distress is not a prerequisite for bankruptcy subject matter jurisdiction pursuant to the Constitution. Instead, the court joins others that have held that the subject matter jurisdiction for bankruptcy extends to all cases filed under the Bankruptcy Code.”

Judge Beyer denied the new motions to dismiss.