Chapter 11 Petition Filed Before Expiration of Holdover, At-Will Tenancy Constitutes Bad Faith Filing

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1 Chapter 11 Petition Filed Before Expiration of Holdover, At-Will Tenancy Constitutes Bad Faith Filing MONIQUE JEWETT-BREWSTER A recent decision makes it clear that courts will examine a plethora of factors in determining whether a Chapter 11 filing has been made in good faith. The U.S. Court of Appeals for the Fourth Circuit has upheld the dismissal of a debtor s Chapter 11 petition filed two days prior to the expiration of a holdover, at-will tenancy. The court found that the debtor s lack of good faith in filing the petition constituted cause for dismissal. 1 The debtor, Premier Automotive Services, Inc., was an import-export motor vehicle company that processed trucks and other equipment through the State of Maryland-owned Dundalk Marine Terminal. Premier operated at the same premises, under a variety of leases, for more than 40 years. Premier s most recent lease for the property expired in June 2002; however, after the lease expired, Premier remained on the leased property as a holdover tenant on a month-to-month basis, while it pursued negotiations with lessor Maryland Port Administration ( MPA ) for a new long-term lease. Monique Jewett-Brewster, an associate at Reed Smith LLP in the Corporate Restructuring and Bankruptcy group, is based in Oakland and can be reached at mjewett-brewster@reedsmith.com. 184

2 CHAPTER 11 PETITION FILED BEFORE EXPIRATION OF HOLDOVER After more than three years of failed lease negotiations with Premier, the MPA entered into a five year lease with a new tenant, and in March 2005, provided Premier with formal notice of the termination of its month-to-month lease. Two days before Premier was to have vacated the property, it filed its Chapter 11 petition, thus invoking the automatic stay provisions of 11 U.S.C. 362(a), and in a related adversary proceeding, alleged a number of various constitutional violations against, inter alia, the MPA. The bankruptcy court subsequently granted the MPA s motion for summary judgment in the adversary action, ordered the automatic stay lifted, and dismissed Premier s Chapter 11 petition. In dismissing the bankruptcy case, the court found that the case had been filed in bad faith, and noted that the expired lease was not property of the estate as contemplated by 11 U.S.C. 521(b). The bankruptcy court further opined that it had no authority to resuscitate a lease that expired by its own terms pre-petition. While the bankruptcy proceedings were pending, Premier filed a complaint with the Federal Maritime Commission ( FMC ) based upon the same facts underlying the bankruptcy case, and alleged therein a number of violations of the Federal Shipping Act. The Administrative Law Judge ultimately dismissed Premier s petition on sovereign immunity grounds. Premier appealed the dismissal of its FMC petition, and, following the dismissal, filed a second action in the federal district court seeking injunctive relief pending final judgment on the FMC appeal. The district court consolidated the bankruptcy appeal and the FMC complaint, affirmed the bankruptcy court s grant of summary judgment in favor of the MPA and dismissed the injunctive relief complaint. The plaintiff once again appealed, and asserted that its bankruptcy case had been filed in good faith because Premier needed the MPA lease to continue its business operations. Premier also asserted that its constitutional claims properly constituted property of the bankruptcy estate. ON APPEAL Evaluating the case, the Fourth Circuit preliminarily observed that its own precedent requires a two-prong analysis to prove a lack of good faith 185

3 PRATT S JOURNAL OF BANKRUPTCY LAW filing: first, an examination of the objective futility test, which focuses on whether there exists a reasonable possibility of an effective reorganization; and second, a review of the subjective bad faith test, which questions whether the filing was made with an improper motivation or for an impermissible purpose. 2 Affirming the lower courts rulings, the court found evidence in the record that supported findings of both objective futility and subjective bad faith in Premier s Chapter 11 filing. In analyzing the objective futility test, the court disagreed with Premier s assertion that the subject litigation actually constituted its plan for an effective reorganization. Noting that Premier had no cognizable property interest in the lease which expired pre-petition, the court concluded that Premier s reorganizationqualitigation strategy was wholly illusory, and that Premier had no realistic possibility of an effective reorganization. Next, the court determined that several factual circumstances supported the lower courts findings that Premier had filed the bankruptcy case in bad faith. Notably, Premier had shown no evidence of financial difficulties at the time of filing. Specifically, the court observed that Premier s bankruptcy filings evidenced its solvency, and revealed no unsecured creditor claims and few, if any, secured claims. Further, the court noted that Premier declined to avail itself of its state law remedies before filing the Chapter 11 petition. Moreover, the court found that the timing of the petition s filing constituted further evidence of bad faith. Reasoning that Premier s Chapter 11 filing was commenced for the improper purpose of avoiding eviction and compelling the MPA to execute a new lease to the debtor on terms more favorable than the MPA found acceptable, the Fourth Circuit concluded that the bankruptcy case had been properly dismissed. The court then examined Premier s contention that, lease interests aside, it had the right to maintain its bankruptcy case because the constitutional claims asserted in the adversary action constituted property of the bankruptcy estate. Particularly, Premier claimed a constitutional property interest in the right to fair negotiations with the State of Maryland in the leasing of state-owned property. Rejecting this analysis, the court concluded that Section 541(b)(2) of 186

4 CHAPTER 11 PETITION FILED BEFORE EXPIRATION OF HOLDOVER the Bankruptcy Code excepts from property of the estate any interest a debtor has in a nonresidential lease that has expired by its own terms prior to the petition filing. The court further found that the most Premier might claim is a right to process, not property, and held that Premier s unilateral expectation that judicially compelled negotiations might culminate in agreement does not rise to the level of constitutionally protected interest. Finally, in upholding the dismissal of Premier s case, the court stressed that allowing a debtor to resort to the bankruptcy process for meritless constitutional claims advanced solely to thwart a lawful eviction would do nothing but subvert the purpose for a Chapter 11 reorganization. CONCLUSION The Fourth Circuit Court of Appeals opinion in the Premier case is demonstrative of the desire by courts from all jurisdictions to limit Chapter 11 petition filings that constitute an abuse of bankruptcy protections. In this particular case, the court of appeals affirmed the bankruptcy court s findings that the debtor had filed its Chapter 11 petition in bad faith, in an effort to invoke the automatic stay and other bankruptcy protections, and forestall its eviction on its long-expired lease. While there is no particular test for determining whether a debtor has filed a petition in bad faith, courts may consider any factors that evidence an intent to abuse the judicial process and the purposes of the Bankruptcy Code s reorganization provisions. In making its determination, the Premier court reasoned that in this essentially two-party dispute, the debtor s solvency; its failure to exhaust state law remedies before filing its petition; and, of course, its eleventh hour filing literally two days before its anticipated date for exiting the leased premises all contributed to a finding that the debtor filed its Chapter 11 petition in bad faith. Other courts, however, have examined the following additional factors in making a determination of whether a Chapter 11 case was filed in bad faith: whether the debtor filed its bankruptcy petition on the eve of a foreclosure of property; if property is indeed foreclosed upon, whether that property is the sole or major asset 187

5 PRATT S JOURNAL OF BANKRUPTCY LAW of the debtor; whether a possibility of reorganization exists; and whether the bankruptcy filing effectively allows the debtor to evade other court orders. In sum, when making the decision to file a Chapter 11 case, debtors should take note of the Premier case, and be aware that courts will examine a plethora of factors in determining whether a Chapter 11 filing has been made in good faith. NOTES 1 In re Premier Automotive Services, Inc., 492 F.3d 274 (4th Cir. 2007). 2 See Carolin Corp. v. Miller, 886 F.2d 693, 702 (4th Cir. 1989). 188