In re Corporate and Leisure Event Productions, Inc.,1 the Bankruptcy Court for the District of Arizona held that a state court lacks the power to enter an order in a receivership proceeding preventing the receivership defendant from filing a petition in bankruptcy.

In Corporate, prior to the petition date, several creditors filed state court actions asserting that they had been defrauded by the debtors and certain related corporate entities (the “Defendants”).2 These state court actions were consolidated, and, in May 2006, the state court appointed a receiver for the Defendants (the “Receiver”). The receivership order authorized the Receiver to remove the Defendants’ directors and officers from “control of, management of, or participation in” the affairs of the Defendants. The receivership order also enjoined the Defendants from interfering with the receiver’s custody and management of the Defendants’ assets and specifically enjoined them from filing a bankruptcy petition without prior permission from the state court.3

After concluding that the debtor had obtained in excess of $44 million in a Ponzi scheme,4 the Receiver took steps to recover the receivership assets, putting the Receiver in conflict with two parties who served as officers, directors and managers of the Defendants (the “O&Ds”). The Receiver argued that the O&Ds were uncooperative, and the O&Ds alleged that the Receiver was destroying the value of the assets.5

In response, the O&Ds filed Chapter 11 petitions for certain of the Defendants between June 8 and June 14, 2006. The debtors promptly removed the receivership action to the Bankruptcy Court. On June 14, 2006, the Receiver removed the O&Ds from their positions as officers, directors and managers of the Defendants.6 On June 19, 2006, the Receiver filed a motion to dismiss the Chapter 11 cases filed on or before June 14, 2006, on the grounds that the O&Ds were not authorized to file the petitions.7 The Receiver did not dispute that the debtors were entities eligible to be debtors under the Bankruptcy Code or that the appropriate filings had been made.8

Faced with the motion to dismiss, the Bankruptcy Court began by noting that the question of who has authority to file a petition in bankruptcy ordinarily

would be an intracorporate dispute with some officers, directors or shareholders objecting to bankruptcy relief and asserting that some other shareholder, officer or director lacked sufficient corporate authority to make the filing. There is apparently no such intracorporate dispute here. Rather, the dispute as to existence of corporate authority is raised by creditors, who prefer the remedy they have in state court over a bankruptcy remedy.9

Turning to the merits of the case, the Bankruptcy Court concluded that the dispute was not governed by the Bankruptcy Code, noting that neither the Receiver nor the complaining creditors alleged that any provision of the Bankruptcy Code had been violated by the Chapter 11 filings.10 Instead, the dispute implicated federal common law.

Examining prior cases discussing this issue, the Bankruptcy Court found that, since 1867, every court to address the issue had found that “state court receivership orders cannot bar debtors from resorting to the exclusive bankruptcy court jurisdiction.”11 Specifically discussing Sixth Circuit case law, the Court found that;

[t]he only cases to the contrary appear to arise when there is a purely intracorporate dispute (rather than a dispute with creditors) as to who has the authority to file, or where the debtor is “ineligible for debtor status” under the Bankruptcy Code.12

The Bankruptcy Court recognized that bankruptcy courts generally look to state law to determine what parties are authorized to file a bankruptcy petition, but concluded that this rule derives from federal common law (and not the language of the Bankruptcy Code).13 Further, the Bankruptcy Court found that there is a federal common law exception when, “the state law is in the form of a receivership order that attempts to preclude any of the original constituents of the organizational entity from filing a petition on its behalf, in order to maintain the state court remedy that has been obtained by creditors.”14 In other words, whether the corporate officers and directors were actually removed by the receiver or the receivership order enjoins their interference or filing of a petition, federal common law provided that the officers and directors retained the power to file a bankruptcy petition for the corporation. The Court noted that, “this common law predates the drafting and adoption of the Bankruptcy Code, so Congress must be assumed to have incorporated it when it drafted the Code.”15

The Bankruptcy Court concluded, “it is clear that Congress did not intend a bright-line rule to govern these issues either way.”16 Although federal common law allows officers and directors of a corporation to file a bankruptcy petition for the corporation even after a receiver is appointed, the Bankruptcy Code provides a bankruptcy court with a means to limit the power of the corporation to avoid receivership administration. For example, section 543(b) of the Bankruptcy Code gives bankruptcy courts discretion to waive the requirement that a receiver turn over estate property to the debtor, if the interests of creditors would be better served by allowing the receivership to continue. Similarly, section 305 of the Bankruptcy Code allows the bankruptcy court to abstain or suspend proceedings in the interests of creditors and the debtor.

Based on the foregoing, the Bankruptcy Court denied the motion to dismiss the Chapter 11 cases that the Receiver had made on the grounds that: the O&Ds were not authorized to file the petitions, without prejudice to the Receiver’s motions to dismiss the cases on other grounds, for excuse from turnover of assets and for abstention and suspension.

Comment

The Corporate case demonstrates the continued implementation of the strong federal policy favoring the availability of bankruptcy relief for financially troubled debtors. Creditors cannot avoid a debtor’s resort to bankruptcy by obtaining relief in state court proceedings.