Last week we blogged about In re Lake Michigan Beach Pottawattamie Resort LLC, a decision from the United States Bankruptcy Court for the Northern District of Illinois that discussed the issues of unauthorized and bad faith filings.  There, we unpacked the court’s holding that the consent of the “blocking director” under the operating agreement was not required for the debtor to commence its chapter 11 case because such provision was void as against public policy.  Here, we examine the court’s ruling that the debtor’s filing was not in bad faith. 

Background

These Lake Michigan squalls began when the debtor defaulted on its mortgage.  Subsequently, the debtor entered into a forbearance agreement with the mortgagor, pursuant to which the mortgagor promised to forbear pursuing remedies for the default until a date certain.  This deadline arrived, and once again the debtor defaulted.  The mortgagor then initiated a non-judicial foreclosure sale, on the eve of which the debtor filed its petition for chapter 11 relief. Notably, at the time of the filing, the debtor’s lone asset, a vacation resort, was valued at over $6,000,000, far exceeding the $2,641,147.89 owed by the debtor to the mortgagor.

Analysis

The mortgagor argued that the debtor’s bankruptcy filing should be dismissed pursuant to section 1112(b) of the Bankruptcy Code because it was a bad faith litigation tactic to stall the foreclosure process.  The court had little sympathy for this argument and noted that it would have summarily dismissed the mortgagor’s motion if it did not also have to decide the blocking director issue.  Nevertheless, in applying the Tekena factors to determine whether this was a bad faith filing, the court highlighted some important considerations.

In re Tekena USA, LLC, 419 B.R. 341, 346 (Bankr. N.D. Ill. 2009) articulated fourteen non-exhaustive factors for determining whether a bankruptcy filing was in bad faith:

  1. The debtor has few or no unsecured creditors;
  2. There has been a previous bankruptcy petition by the debtor or a related entity;
  3. The pre-petition conduct of the debtor has been improper;
  4. The petition effectively allows the debtor to evade court orders;
  5. There are few debts to non-moving creditors;
  6. The petition was filed on the eve of foreclosure;
  7. The foreclosed property is the sole or major asset of the debtor;
  8. The debtor has no on-going business or employees;
  9. There is no possibility of reorganization;
  10. The debtor’s income is not sufficient to operate;
  11. There was no pressure from non-moving creditors;
  12. Reorganization essentially involves the resolution of a two-party dispute;
  13. A corporate debtor was formed and received title to its major assets immediately before the petition; and
  14. The debtor filed solely to create the automatic stay.

The mortgagor relied on factors 1, 2, 6, 7, 8, 9, and 12 in making its bad faith argument. The court quickly dismissed the mortgagor’s argument on the first factor by pointing to two other creditors listed on the debtor’s schedules.  Similarly, the court held that the mortgagor’s argument on the second factor – that the debtor’s default equated to a prior bankruptcy – “strains its credibility.”

The mortgagor argued that the sixth Tekena factor presented the most compelling indication of bad faith because the debtor filed its petition on the eve of foreclosure.  Although the court agreed that this factor was satisfied, it emphasized that the timing of a filing is the most abused of the Tekena factors and does not, by itself, establish a bad faith filing.  Likewise, the court agreed with the mortgagor that the seventh factor was satisfied, but emphasized that it “cannot conclude that a case is filed in bad faith simply because there is but one asset around which to reorganize.”

With respect to the eighth Tekena factor, the mortgagor argued that the debtor had no on-going business because it was not operating at the time of the bankruptcy filing.  The court rejected this argument, explaining that although the debtor’s seasonal vacation resort business was not presently operating, the debtor had sufficient assets with which it could operate an on-going business during the peak summer seasons.

Finally, the court dismissed the mortgagor’s arguments on the ninth and twelfth Tekena factors on the grounds that the mortgagor’s consent was not required for a reorganization because the debtors had two other creditors and significant equity in the mortgaged property.

Considering the Tekena factors together, the court held that bad faith had not been established.  The court left its readers with the takeaway, which we will now leave for our readers, that where the debtor’s single asset is real property and the bankruptcy petition is filed on the eve of foreclosure, the presence of equity provides substantial evidence of the debtor’s good faith intent to reorganize.