Contributed by Amy B. Price
Filing for chapter 11 gives debtors an opportunity for a “fresh start” with the help of the Bankruptcy Code’s unique powers, such as the automatic stay. Although chapter 11 may present an appealing alternative to paying one’s debts or incurring litigation liability, courts will not tolerate petitioners who attempt to exploit the bankruptcy system. In the cautionary tale of In re SGL Carbon Corporation, the feature of this Throwback Thursday, the Third Circuit reminds us that the right to seek bankruptcy protection is not absolute. In SGL Carbon, the court held, as a matter of first impression, that a chapter 11 petition not filed in good faith is subject to dismissal “for cause” pursuant to section 1112(b) of the Bankruptcy Code.
The case involved SGL Carbon Corporation, a manufacturer and seller of graphite products used in steel production. After the United States Department of Justice initiated an investigation of alleged price-fixing by manufacturers like SGL, SGL found itself among the targets of a class action antitrust lawsuit. Indeed, a class was certified against it pursuant to Federal Rule of Civil Procedure 23, and certain class members who opted out of the class initiated separate individual lawsuits against SGL. SGL’s parent corporation determined a best estimate of the potential liability SGL would face in the criminal and civil antitrust litigation. Shortly thereafter, SGL filed a voluntary chapter 11 petition in the United States District Court for the District of Delaware. The case was not referred to the bankruptcy court. The petition cited the antitrust litigation as the sole factor leading to the filing of the chapter 11 case. In the proposed plan of reorganization, all creditors would be paid in full, except antitrust plaintiffs who obtained a judgment against SGL.
The petition was followed by a series of press releases, which advertised the company’s financial health and blamed the bankruptcy filing on the “excessive and unreasonable demands” of the antitrust plaintiffs. Two weeks later, the United States Trustee formed a nine member Official Committee of Unsecured Creditors, including eight members who were plaintiffs in the antitrust litigation. The Committee soon filed a motion to dismiss the chapter 11 petition on the ground that it was merely a “litigation tactic designed to frustrate the prosecution of the civil antitrust claims pending against SGL.”
The district court denied the Committee’s motion to dismiss, finding that the petition furthered the purposes of chapter 11 because the litigation was imperiling SGL’s operations by “distracting its management, was potentially ruinous and could eventually force the company out of business.” The Committee appealed to the Third Circuit.
Section 1112(b) governs the dismissal of chapter 11 cases and provides, in relevant part, that a court shall dismiss a case under chapter 11 “for cause.” This section also lists sixteen factors that may constitute “cause” warranting the dismissal of a petition. As a threshold inquiry, the Third Circuit addressed whether the absence of good faith in filing a chapter 11 petition constitutes “cause” warranting dismissal under section 1112(b). The court answered in the affirmative, based on four factors including the statutory language of section 1112(b) and its legislative history; decisions of other courts of appeal; “the equitable nature of bankruptcy; and the purposes underpinning [c]hapter 11.” After reasoning that the list of enumerated factors in section 1112(b) is not exclusive and that courts are permitted to consider whether other factors could constitute “cause,” the Third Circuit emphasized that “[a] good faith standard furthers the balancing process between the interests of debtors and creditors which characterizes so many provisions of the bankruptcy laws and is necessary to legitimize the delay and costs imposed upon parties to a bankruptcy. Requirement of good faith prevents abuse of the bankruptcy process by debtors whose overriding motive is to delay creditors without benefiting them in any way . . . .”
Importantly, although a debtor need not be insolvent before filing for bankruptcy, the court stressed that the Bankruptcy Code does not invite petitions that lack “a valid reorganizational purpose.” The court emphasized the “considerable powers” with which chapter 11 debtors are vested, citing the automatic stay, the exclusive right to file a plan of reorganization, and the discharge of debts, and explained that affording a debtor with such powers must be justified. Indeed, if the petitioner has no need to reorganize, a chapter 11 “petition cannot serve the rehabilitative purpose for which [c]hapter 11 was designed.”
As applied to SGL’s petition, the court concluded that the petition had not been filed in good faith and dismissal was warranted. The court conducted a “fact intensive inquiry” to determine where the petition fell “along the spectrum ranging from the clearly acceptable to the patently abusive.” In so doing, the court rejected the district court’s finding that the antitrust litigation had posed a serious threat to the company’s health, and found that, if anything, it was filing for bankruptcy that had distracted the company’s management. Moreover, the record demonstrated that even if a petition would be necessary at some time as a result of antitrust liability, SGL had filed too early because it failed to demonstrate any financial difficulty or managerial distraction as of the time of filing. Thus, the “attenuated possibility” of financial difficulty and managerial distraction, without more, was not sufficient to establish good faith. Although the court acknowledged the hardships accompanying large scale litigation and the potential for massive liability for corporate defendants, the need to protect the integrity of the bankruptcy system necessitated a finding that chapter 11 cannot be used as a first-resort safe harbor for a financially healthy company.
This nostalgic look back at SGL Carbon underscores that filing for chapter 11 is a privilege. Moreover, courts take seriously their role as gatekeepers of chapter 11 and are empowered by the Bankruptcy Code to reject bad faith filings.