Restructuring

Contributed by Lee Jason Goldberg
In a prior entry, we discussed the unique decision of the United States Bankruptcy Court for the Northern District of Texas in In re 1701 Commerce, LLC, where the court declined to dismiss a chapter 11 case or, alternatively, lift the automatic stay, even though the court found the debtor to have filed its case in bad faith, which constituted “cause” to grant the relief requested.  Instead, the court fashioned its own remedy – conditioning continuation of the stay in order to protect the “public interest.”  In this post, we explore the court’s rationale for its creative remedy and contrast it with previous decisions of the same court opting not to consider the “public interest” in determining whether to grant or deny relief.
Citing two “exceptional cases,” In re Mirant Corp. and NLRB v. Bildisco & Bildisco, well known for promulgating a heightened, or “public interest,” standard for rejection of certain executory contracts, the court in 1701 Commerce held that “[a]s with any chapter 11 case, the court must consider the legitimate interests of others in deciding whether to grant either of the [m]otions.”  The court cited no other cases – including any cases specifically addressing bad faith in the dismissal or stay relief contexts – where the bankruptcy court was required to consider the legitimate interests of others in deciding a motion before it.
The court observed that, generally, in bankruptcy matters, the “public interest” is served by preserving value and jobs where possible, thus alluding to the Supreme Court’s finding in Bildisco that the “fundamental purpose of reorganization is to prevent a debtor from going into liquidation, with an attendant loss of jobs and possible misuse of economic resources.”  The court’s factual findings did not indicate that there was a risk of liquidation of the debtor; granting either motion, however, would return the parties to state court, where, the court found, the debtor’s hotel “and by extension the City [of Fort Worth]” would serve as a “fraying rope in a continuing tug of war” between the senior and junior lenders.  Expecting the hotel to maintain, let alone improve, the quality of its operations in those circumstances was unrealistic.
Even though the court found that the debtor had filed its chapter 11 petition in bad faith, constituting the requisite “cause” to dismiss the case or lift the stay, the court also found that the hotel had “significance for other parties whose interests deserve[d] deference from the court.”  The main “other party” explicitly afforded deference by the court was the City of Fort Worth, which, according to the court, represented the “public interest” through a tax incentive agreement between Fort Worth and the non-debtor borrower.  The court, noting that the tax incentive agreement reflected the hotel’s importance to Fort Worth’s plan for economic growth and development, took judicial notice of such plan and gave “deference” to the findings Fort Worth made in connection with it.  The court found, therefore, that the public had a “significant interest” in the hotel’s operation as a “first class hotel” in accordance with the tax incentive agreement.  Implying that it was required to consider such interests by using the word “must,” the court implemented its own remedy – allowing the case to remain in chapter 11 but conditioning continuation of the automatic stay.
The court did not need to make a bad faith finding to fashion its remedy, though.  The senior lender had sought dismissal of the chapter 11 case under section 1112(b) or, alternatively, relief from the automatic stay under section 362(d).  Under sections 1112(b)(1) and 362(d)(1), a bankruptcy court “shall,” respectively, dismiss the case or terminate, annul, modify, or condition the stay if it finds “cause.”  Section 1112(b)(4) sets forth a nonexclusive list of what constitutes “cause” requiring a court to dismiss the case, but a finding of bad faith is not listed.  Similarly, section 362(d)(1) includes one example of “cause” that would warrant relief from the stay, but that example is not a finding of bad faith.
The Fifth Circuit has noted that “for cause” is “not defined in the statute so as to afford flexibility to the bankruptcy court” and that “[n]umerous cases have found a lack of good faith to constitute ‘cause’ for lifting the stay to permit foreclosure or for dismissing the case.”  Instead of enunciating a per se rule, the Fifth Circuit has set forth factors for courts to use to identify a bad faith filing and stated that “[d]etermining whether the debtor’s filing for relief is in good faith depends largely upon the bankruptcy court’s on-the-spot evaluation of the debtor’s financial condition, motives, and the local financial realities.”
Although the 1701 Commerce court found many of the bad faith factors present, the hotel was an “operating business” sharing many attributes of a single-asset real estate venture that “would invoke Chapter 11 in good faith”:  there was a going concern to preserve (including by maintaining the hotel’s “first-tier flag”); there were employees to protect (while not the debtor’s employees, the debtor’s bankruptcy filing jeopardized their jobs); and there was hope of rehabilitation (the court’s remedy was aimed at expediting such rehabilitation).  In other words, the facts and circumstances of 1701 Commerce did not compel a bad faith finding.
Because of the “flexibility” afforded by the undefined term “cause” in, and the “broad range of relief” authorized by, section 362(d), the court could have implemented its remedy, balancing its unease regarding the debtor’s bankruptcy filing and desire to protect the senior lender’s position with the benefits of the debtor’s remaining in bankruptcy, including prevention of job loss and misuse of economic resources, without making a bad faith finding.  Such an approach would have vindicated the fundamental chapter 11 policy articulated by the Supreme Court in Bildisco – and echoed by the court in looking to the “public interest” (i.e., “preserving value and jobs”) – without implying, by finding bad faith, that the debtor had improperly resorted to the protection of the bankruptcy laws.
While the Fifth Circuit has indicated that the “public interest” is safeguarded by bankruptcy courts’ enforcement of a standard of good faith, which prevents abuse of the bankruptcy process, the 1701 Commerce court’s deference to local economic policy in the name of the “public interest” raises questions as to which “public interest” should be considered in granting or denying relief.  Indeed, the court’s consideration of the “public interest” in 1701 Commerce contrasts with the court’s rationale for refusing to consider the “public interest” in the context of other sections of the Bankruptcy Code in both In re Pilgrim’s Pride Corp. and In re General Electrodynamics Corp., where the court nonetheless recognized the harm to communities that could result from permitting contract rejection or denying plan confirmation, respectively.
In Pilgrim’s Pride, the court declined to apply a heightened, or “public interest,” standard to the debtors’ rejection of executory contracts, noting that “the more stringent Bildisco/Mirant test will be rarely applied.”  The General Electrodynamics court, in determining that a chapter 11 plan was not confirmable, found that the Bankruptcy Code “makes no provision for the court to override the requirements of confirmation in favor of the public interest.”  In both of those cases, the court grounded its refusal to consider the “public interest” in statutory construction and general bankruptcy policy.
As for statutory construction, the court in Pilgrim’s Pride and General Electrodynamics observed that Congress has stated when it wishes courts to consider the “public interest,” pointing to the part of the Bankruptcy Code dealing with railroad reorganizations.  While noting that “the court, in some contexts, may be able to take the public interest into account in the absence of specific statutory authority” (e.g., Mirant), the General Electrodynamics court cautioned that “it must still adhere to the specific terms of the [Bankruptcy] Code.”
Similarly, the Pilgrim’s Pride court, acknowledging that it was bound by Bildisco and Mirant, observed that “the statutory construction arguments against applying a different test for rejection to some contracts support the court’s view that the public policy exception to the business judgment rule should be a very narrow one.”  Accordingly, the court in Pilgrim’s Pride delineated a “threshold showing” for application of the “public policy exception” (i.e., the “rarely applied” Bildisco/Mirant test) for rejection of executory contracts in light of its concern that second-guessing every choice by a debtor that may “economically harm any given locale” could lead to such “public policy exception” swallowing the business judgment rule applicable to contract rejection and other decisions in the chapter 11 process.
The 1701 Commerce decision, by contrast, does not clarify in what circumstances the “public interest,” as articulated by the court, should be considered in the context of bad faith filings, leaving unanswered the questions of why Fort Worth’s economic policy was entitled to deference and how a court should determine whether and when deference should be granted to local public policies – and to which ones.  Different expressions of the “public interest” are found in bankruptcy case law and in local statutes, regulations, and policy pronouncements.  The court’s refusal to dismiss the case or lift the stay notwithstanding the debtor’s bad faith filing raises the question of how a court should determine when a local public policy represents a greater “public interest” (such that it should be granted “deference”) than the “public interest” in preventing abuse of the bankruptcy process (by the requirement that chapter 11 cases be filed in good faith).
The 1701 Commerce decision also provokes other questions.  For example, how are debtors and creditors able to predict when the “public interest” – and which “public interest” – may be invoked as a basis for a court’s granting or denying relief?  Could 1701 Commerce be cited as precedent for courts to consider the “public interest” in applying other sections of the Bankruptcy Code?  While the court’s decision in 1701 Commerce may have given the parties peace of mind as to the future of the hotel’s sojourn in bankruptcy, it may sew new uncertainty in the world of bad faith filing litigation and beyond.