‘Litigation Gymnastics' Causes Ch. 7 Case Dismissal

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By Diane Davis

Nov. 9 — Bad faith — or any unjustified refusal to pay one's debt — can amount to “cause” for dismissal of a debtor's Chapter 7 bankruptcy case, a district court in Illinois held Nov. 2.

Judge Robert M. Dow, Jr., vacated the bankruptcy court's ruling denying appellant BMO Harris Bank N.A.'s motion to dismiss the debtors' Chapter 7 bankruptcy petition, and remanded the case for reconsideration.

‘Cause' for Dismissal

While bad faith isn't an explicit ground for dismissal under Bankruptcy Code Section 707(a), “it can amount to ‘cause' for dismissal,” the court said. Section 707(a) allows a bankruptcy court, after notice and hearing, to dismiss a Chapter 7 petition “for cause” and provides a list of three factors that can constitute “cause,” including “(1) unreasonable delay by the debtor that is prejudicial to creditors, (2) nonpayment of any fees or charges required under the Bankruptcy Code, and (3) failure of the debtor to file certain information required by the Bankruptcy Code.”

By rejecting the possibility that certain bad-faith acts can ever justify dismissal under Section 707(a), the bankruptcy court applied the wrong legal standard, the court said.

The bankruptcy court's “stance that bad faith can never constitute “cause” for dismissal under § 707(a) is contrary to law after In re Schwartz, 2015 BL 271870, 799 F.3d 760 (7th Cir. 2015), the court said.

In Schwartz, the Seventh Circuit sided with the Sixth, Eighth, and Eleventh Circuits in holding that the “‘for cause' provision in § 707(a) ‘embrace[s] conduct that, while not a violation of required procedures, avoids repayment of debt without adequate reason,'” the court said.

Whether a Chapter 7 case can be dismissed on bad faith grounds under Section 707(a) is “one of the older debates in bankruptcy law,” the court said, noting that there has been a split of authority among the circuit courts with the Eighth and Ninth Circuits siding with the debtors rather than the appellants in this case.

Last Minute Ch. 13 Filing

Debtors Eric and Kimberly Isaacson, through their wholly-owned company IKE Services, LLC, took out a loan from appellant's bank for $1.3 million. The loan was secured by a mortgage that granted the bank a mortgage lien on 10 rental properties in Illinois.

After the debtors defaulted on the loan, the bank filed a state foreclosure action and obtained summary judgment against IKE and the debtors. The rental properties were sold, resulting in a deficiency judgment of $1 million.

On the eve of when the foreclosure court was scheduled to enter a money judgment against the debtors for the $1 million deficiency, the debtors filed for Chapter 13 protection. Later, the trustee moved to dismiss the case because the debtor's scheduled debts exceeded the statutory limit for a Chapter 13 proceeding.

The bankruptcy court converted the case to Chapter 11, but subsequently, converted it again to Chapter 7 because the debtors couldn't propose a confirmable Chapter 11 plan.

‘Litigation Gymnastics.'

The appellant bank argued that the debtor's “litigation gymnastics” showed a lack of good faith. According to the bank, the “filing of a Chapter 13 petition knowing that they were not eligible for Chapter 13 relief combined with their inability to propose a confirmable Chapter 11 plan demonstrate a lack of good faith.”

According to the bank, the debtors are both management-level employees at Wal-Mart with a combined annual salary of $263,000, have more than $1 million in retirement funds, and have the ability to repay their creditors without the need for bankruptcy protection. The debtors filed their bankruptcy petition to avoid the judgment entered in the foreclosure case, the bank argued. The bank also contended that the debtor's failure to disclose their bonuses during the bankruptcy case showed a “lack of candor with the court and their creditors.”

The bankruptcy court determined that it had no reason to dismiss the debtor's bankruptcy case.

The bank appealed to the district court, arguing that the appropriate legal test for assessing a motion to dismiss under Section 707(a) was applied. The bank asked the court to remand the case back to the bankruptcy court to determine whether the debtors' actions constituted bad faith, and if so, to dismiss the case.

‘Bad Faith' Dismissals Allowed

While Section 707(a) provides three enumerated factors that can constitute “cause” for dismissal, the “including” language should be read as “including, but not limited to,” such that “the list of factors is illustrative, not exhaustive,” the court said, citing Schwartz.

The Seventh Circuit has adopted the rationale of the circuit court cases holding that Section 707(a) allows for “bad faith” dismissals, the court said, but “shied away from adopting any formalistic ‘bad faith' analysis.”

In Schwartz, the Seventh Circuit determined that bankruptcy courts have the discretion to dismiss cases for “cause” under Section 707(a) “wherever there is an unjustified refusal to pay one's debts … regardless of whether the debtors' conduct amounts to ‘bad faith,'” the court said.

While bad faith isn't an explicit ground for dismissal under Section 707(a), bad faith can amount to “cause” for dismissal, the court concluded.

Scott C. Frost, Daniel S. Rubin, Howard and Howard Attorneys, PLLC, Chicago, represented appellant BMO Harris Bank NA; David P. Lloyd, David P. Lloyd, Ltd., La Grange, Ill.; Arnold H. Landis, Law Office of Arnold H. Landis, Chicago, represented appellees Eric and Kimberly Isaacson.

To contact the reporter on this story: Diane Davis in Washington at ddavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at mailto:%20jhorowitz@bna.com

Full text at: http://www.bloomberglaw.com/public/document/BMO_Harris_Bank_NA_v_Isaacson_No_15cv2528_2015_BL_361674_ND_Ill_N