Bankruptcy Bad Faith Filings: Proving Cause Exists to Dismiss A Case Under Section 1112(b); Increased Scrutiny

Testing a debtor's right to seek bankruptcy relief is a powerful tool in any case, and judges are paying attention. Almost all courts have agreed that "cause" sufficient to require dismissal or conversion under 11 U.S.C. § 1112 of a Chapter 11 case includes lack of "good faith" (aka bad faith). Starting with In re National Rifle Association of America and Sea Girt L.L.C., Case No. 21 30085 (HDH) (Bankr. N.D. Tex. 2021), creditors have had increasing success in evicting a debtor from bankruptcy. 

Although courts must find cause before dismissing a case, the Bankruptcy Code does not define either cause or good faith. Different courts have taken different approaches. The Third Circuit took an unprecedented approach when it dismissed In re LTL Management L.L.C. multiple times for lack of legitimate bankruptcy purpose and lack of genuine financial distress. Subsequent courts have described financial distress as necessary but not sufficient to establish good faith; others have noted that waiting until insolvency makes reorganization more difficult. Many jurisdictions apply a totality of the circumstances test for good faith or require the subjective bad faith of the debtor before dismissing the case. Courts have also placed the burden of establishing good faith or a lack of bad faith on different parties at different times and shifted the burdens of proof as evidence is presented.

Listen as our experienced panel of bankruptcy and restructuring lawyers discusses how litigants are using motions to dismiss or convert to resist using bankruptcy as a method of resolving non-bankruptcy problems.