United States: Their Purpose Wasn’t True – NRA Bankruptcy Filings and Bad Faith
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Bankruptcy provides a temporary sanctuary for parties seeking relief from a variety of issues – financial crisis, lawsuits, collection actions, foreclosures, foreclosures and pandemics.
Filing for bankruptcy before a pecuniary judgment is entered or on the eve of a foreclosure sale is – often to the dismay of creditors – perfectly valid. Creditors often complain that the debtor is acting in bad faith, and the bankruptcy court should dismiss the case. These arguments almost always fail.
But not all bankruptcy cases survive long enough for a debtor to reorganize. When a case is genuinely filed in “bad faith”, the bankruptcy court can and often will dismiss it. So when a Texas bankruptcy court recently dismissed the Chapter 11 case filed by the National Rifle Association, it opened up an examination of what constitutes a bad faith filing under the Bankruptcy Code.
The NRA was sued by the New York attorney general, who alleged that the NRA had committed a variety of illegal acts in violation of New York laws governing nonprofit organizations. The New York attorney general has the power to sue charities like the NRA, and if successful, one of the potential remedies is for the charity to be dissolved. The NRA sought to avoid coercive action – and in particular the specter of disbandment – by declaring bankruptcy and moving to Texas.
When a party files for bankruptcy, it must do so for a valid purpose of bankruptcy; otherwise, it is a deposit in bad faith. Valid bankruptcy purposes include avoiding foreclosure, avoiding having to close operations, reducing operating costs, dealing with heavy contracts and leases, streamlining and consolidating litigation, attempting to preserve a running business, or simply obtaining respite from dealing with creditors. A petition filed simply to gain a tactical advantage in litigation is a bad faith filing.
To determine good faith versus bad faith, courts must consider all of the circumstances based on the debtor’s financial situation, motives, and local financial realities. No factor is decisive. Since the court must assess and decide the issue, the testimony of witnesses – especially parties who have decided to file the case – is a critical factor. The party requesting the revocation bears the burden of proving the bad faith of the debtor. If that party can gather enough evidence to suggest bad faith, then the onus is on the debtor to prove that he acted in good faith.
After a 12-day trial with 23 witnesses, the bankruptcy court concluded that the NRA’s bankruptcy petition was not filed in good faith based on all of the circumstances. The NRA was not in financial difficulty and had funds to pay all of its creditors in full. The NRA filed its motion for an unfair litigation advantage in the New York attorney general’s enforcement action. New York might still be able to get a financial judgment, but the NRA wanted to take the dissolution off the table. The enforcement action was different from a lawsuit brought by a disgruntled seller. This was to enforce New York’s regulatory regime for charities, and the NRA was using bankruptcy to try to avoid that regulatory regime. This was not a legitimate goal of bankruptcy.
The lesson for creditors is that, although infrequent, there are circumstances in which a bankruptcy court will dismiss a case. If the debtor has made a complaint for a manifestly inappropriate purpose, you can have it dismissed. But in order to pursue dismissal and be successful, you must be prepared to go to trial and present convincing evidence of bad faith in court through documents and testimony.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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