Solvent Debtors and Good Faith

Solvent Debtors and Good Faith

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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.1 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 In a decision from early 2005 that was unpublished as of the deadline for submitting this article, the court from the Northern District of Texas provides some answers.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).

Questions of Good Faith

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).2 Pursuant to its strategy, the debtor in Integrated Technologies was seeking to reduce its liability to its landlord by approximately $21 million.3 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.4 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.5 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.6

Solvent Debtors Revisited

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.7 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.8 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?9

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."10 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.11 Since the whole corporate enterprise needed rehabilitation, the court found that MirMA met the good-faith requirement under the corporate family test.12

The court next examined the MirMA filing under the "valid bankruptcy test" to determine good faith.13 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.14 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.15 The court found that management's concerns were a valid reason for filing for bankruptcy.16

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

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.20 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.21 Thus, since the dismissal would potentially cause harm to MirMA and its affiliates, the court denied the motion to dismiss.22

Appeal to Follow

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.


1 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. Return to article

2 See 384 F.3d at 127. Return to article

3 See 384 F.3d at 116. Return to article

4 See 384 F.3d at 121. Return to article

5 See 384 F.3d at 129. Return to article

6 See 384 F.3d at 129. Return to article

7 See Mirant, p.1 and p. 6. Return to article

8 See Mirant, p. 3. Return to article

9 See Mirant, p. 10. Return to article

10 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). Return to article

11 See Mirant, p. 13. Return to article

12 See Mirant, p. 13. Return to article

13 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. Return to article

14 See Mirant, p. 14. (quoting from Integrated Telecom). Return to article

15 See Mirant, p. 14. Return to article

16 See Mirant, p. 16-17. Return to article

17 See Mirant, p. 18. Return to article

18 See Mirant, p. 19. Return to article

19 See Mirant, p. 19-20. Return to article

20 See Mirant, p. 22. Return to article

21 See Mirant, p. 23-24. Return to article

22 See Mirant, p. 23-24. Return to article

Bankruptcy Code: 
Journal Date: 
Tuesday, March 1, 2005