Commercial Litigation and Arbitration

Sanctions — “This Appeal … Can Only Be Described as an Exercise in Chutzpah” (Good Quote) — Bankruptcy Court Has Authority to Dismiss a Chapter 7 Case for Cause for Bad Faith Litigation Abuse

Krueger v. Torres (In re Krueger), 812 F.3d 365 (5th Cir. Tex. Jan. 19, 2016):

This appeal of a bankruptcy court decision dismissing a chapter 7 case "for cause" can only be described as an exercise in chutzpah. The debtor flagrantly and repeatedly abused bankruptcy and court processes to retain assets for himself and defeat the legitimate claims of his business partners. The bankruptcy and district courts finally had enough of his manipulation and rightly dismissed pursuant to 11 U.S.C. § 707(a) for the debtor's bad faith conduct constituting "cause" for dismissal. We AFFIRM.


II. Bad Faith Conduct as "Cause" for Dismissal of a Chapter 7 Case

Krueger's main argument on appeal is that his bad faith behavior in the bankruptcy process is not "cause" for dismissal under § 707(a).

Under § 707(a), a "court may dismiss a case under this chapter only after notice and a hearing and only for cause." (emphasis added). The statute lists three grounds "for cause" that all courts have understood as illustrative, not exclusive: 1) "unreasonable delay by the debtor that is prejudicial to creditors" 2) "nonpayment of any fees or charges" required to file a case and 3) "failure of the debtor in a voluntary case to file" schedules and creditor lists. Id.

This circuit joins those courts that have held a debtor's bad faith in the bankruptcy process can serve as the basis of a dismissal "for cause," even if [*11]  the bad faith conduct is arguably encompassed by other provisions of the Code. This is no more than acknowledgement in the chapter 7 context of what has long been recognized: "Every bankruptcy statute since 1898 has incorporated literally, or by judicial interpretation, a standard of good faith for the commencement, prosecution, and confirmation of bankruptcy proceedings." Little Creek Dev. Co. v. Commonwealth Mortg. Co. (In re Little Creek Dev. Co.), 779 F.2d 1068, 1071 (5th Cir. 1986).

Courts have broad authority to determine what is cause for dismissal under § 707(a): "[C]ause is any reason cognizable to the equity power and conscience of the court as constituting an abuse of the bankruptcy process." Id. at 1072 (quoting In re Victory Constr. Co., Inc., 9 B.R. 549, 558-60 (Bankr. C.D. Cal. 1981)) (internal quotation marks omitted). This can include "prepetition bad-faith conduct," see Marrama v. Citizens Bank of Mass., 549 U.S. 365, 373, 127 S. Ct. 1105, 1111, 166 L. Ed. 2d 956 (2007), postpetition bad faith conduct, or petitions that simply serve no legitimate bankruptcy purpose, see, e.g., Kelley ex rel. Petters Co., Inc. v. Cypress Fin. Trading Co., L.P. (In re Cypress Fin. Trading Co., L.P.), 620 F. App'x 287, 289 (5th Cir. 2015) (per curiam); see also Daniels v. Barron (In re Barron), 325 F.3d 690, 694-95 (5th Cir. 2003) (Jones, J., concurring).

This broad reading of "cause" is faithful to the dictionary meaning of that term, see Piazza v. Nueterra Healthcare Physical Therapy, LLC (In re Piazza), 719 F.3d 1253, 1261 (11th Cir. 2013) (collecting dictionary definitions), the customary judicial understanding of that term, and the flexibility traditionally afforded to bankruptcy courts. See Little Creek, 779 F.2d at 1072; see also Jacobsen v. Moser (In re Jacobsen), 609 F.3d 647, 660 (5th Cir. 2010) (holding that debtor's "bad faith" and "abuse[]" of the bankruptcy process was relevant to the cause inquiry [*12]  under in 11 U.S.C. § 1307(c)); Atlas Supply Corp., 857 F.2d at 1063 (bankruptcy courts evaluating § 707(a) motions "must balance the equities and weigh the benefits and prejudices of a dismissal." (internal quotation marks omitted)).

Recently, the Seventh Circuit read § 707(a) broadly in finding that "unjustified refusal to pay one's debts is a valid ground" for dismissal. See In re Schwartz, 799 F.3d 760, 764 (7th Cir. 2015). The Schwartzes filed a chapter 7 petition, but not before they depleted their assets substantially through profligate spending. Id. at 761-62. Their primary creditor moved to dismiss under § 707(b), the means-testing threshold for mandatory Chapter 13, but the bankruptcy court pretermitted the § 707(b) analysis and dismissed the case for cause under § 707(a) instead. Id. at 763. On appeal, the Seventh Circuit affirmed the bankruptcy court, finding "cause" "to embrace conduct that . . . avoids repayment of debt without an adequate reason." Id. Here, "the Schwartzes failed to . . . pay as much of their indebtedness as they could without hardship. Their action was deliberate and selfish, and provides good cause for denying the discharge." Id. at 763-64. The more specific § 707(b) formula for evaluating "can pay" debtors was no obstacle to affirming a § 707(a) dismissal.

Likewise, the Eleventh Circuit holds that prepetition bad faith is "cause" to dismiss a [*13]  chapter 7 petition. See Piazza, 719 F.3d at 1262. In Piazza, the court affirmed dismissal of the chapter 7 of a debtor who sought to discharge a debt owed to a single judgment creditor who was gaining traction in an effort to collect via the Florida state court system. Id. at 1258-59. The debtor had also failed to adjust his lifestyle in order to pay his judgment creditor, but had made payments to certain insider creditors. Id. at 1273-74. The Eleventh Circuit rejected all of the statutory interpretation arguments that Krueger raises here and turned aside the idea that § 707(a)'s "for cause" standard is limited by more specific Code provisions. Id. at 1267-68. Instead, the court endorsed finding cause under a "totality of the circumstances" approach, because "[b]ad faith does not lend itself to a strict formula" but encompasses "atypical conduct that falls short of the honest and forthright invocation of the Code's protections." Id. at 1271 (internal quotation marks, citations, and alteration omitted).

Other courts concur that § 707(a) is to be read expansively. See, e.g., Tamecki v. Frank (In re Tamecki), 229 F.3d 205, 207-08 (3d Cir. 2000) (Duhé, J., sitting by designation) (debtor ran up huge debts and filed bankruptcy in anticipation of receiving money post-filing in a divorce settlement); see also Indus. Ins. Servs., Inc. v. Zick (In re Zick), 931 F.2d 1124, 1129 (6th Cir. 1991) (debtor sought chapter 7 bankruptcy shortly [*14]  after an adverse mediation award was entered). The court in Zick said that it was permissible to consider the debtor's "malicious breach" of his non-compete agreement and his "manipulations which reduced the creditors in this case to one" in the § 707(a) analysis. Id. at 1128-29.

In judging whether there is cause to dismiss a case, a court may consider the debtor's entire course of conduct--before, during, and after the filing of a chapter 7 petition. Embraced by this wide-ranging inquiry are acts or omissions arguably covered by more specific provisions of the Code. Krueger strenuously objects to this proposition. Drawing support from the Eighth and Ninth Circuits, Krueger asserts that the general "for cause" dismissal standard under § 707(a) is limited by Code provisions that offer specific remedies for the bad faith conduct at issue here. See Neary v. Padilla (In re Padilla), 222 F.3d 1184, 1191-94 (9th Cir. 2000); see also Sherman v. SEC (In re Sherman), 491 F.3d 948, 970 (9th Cir. 2007). And although the Eighth Circuit held that bad faith dismissals for cause under § 707(a) should be limited to "extreme misconduct falling outside the purview of more specific Code provisions," nevertheless, where the debtor used a bankruptcy filing to "frustrate [a] divorce court decree and push his ex-wife into bankruptcy," his "non-economic motives" were "unworthy of [*15]  bankruptcy protection." Huckfeldt v. Huckfeldt (In re Huckfeldt), 39 F.3d 829, 832 (6th Cir. 1994). The Eighth Circuit affirmed the dismissal for cause.

Krueger's argument relies on the canon of statutory interpretation that a specific provision governs a more general one. See, e.g., RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065, 2071-72, 182 L. Ed. 2d 967 (2012). Because §§ 523, 707(b), and 727 of the Code address some of the misconduct complained of here, Krueger contends that the bankruptcy court erred in relying on the more general "for cause" language in § 707(a) to dismiss the case.

Reliance on the general/specific canon is misplaced, however, because of the "textual indications that point in the other direction." Id. at 2072. First, Congress chose to include the broad language of "for cause" in § 707(a) without any textual qualification. Second, the Code provisions cited do not simply cover the same conduct or result in the same remedy: § 707(b) applies only to individual debtors with primarily consumer debts while § 707(a) applies to any chapter 7 filer. Sections 523(a)4 and 727(a)5 each prescribe different remedies for a more limited universe of conduct than that covered under § 707(a). Both typically result in the permanent denial of dischargeability or discharge. See Piazza, 719 F.3d at 1268. Section 707(a) allows dismissal with a temporary bar on refiling. Additionally, §§ 523 and 727 take effect at the conclusion of the case; they do nothing to limit the [*16]  abuse of the process of bankruptcy and its "powerful equitable weapons" while the process is ongoing. Little Creek, 779 F.2d at 1072. Section 707(a), however, allows the court to enforce its authority and prevent ongoing dishonest and vexatious conduct during the case. Finally, while §§ 523 and 727 allow a bankruptcy court to target specific bad acts, only § 707(a) allows the court to consider a concerted scheme of bankruptcy abuse.

4   Containing an exception to discharge for indebtedness for, among other things, debt obtained by "false pretenses, a false representation, or actual fraud."

5   Denying discharge where, among other things, the debtor failed to keep certain records, "made a false oath or account," or withheld information from the bankruptcy estate.

Krueger's other statutory interpretation arguments have been convincingly rebutted by other courts. See Piazza, 719 F.3d at 1262-70. His suggestion that the enumerated, illustrative examples in § 707(a) are technical and procedural in nature (and thus any other § 707(a) grounds should be technical and procedural) is simply not true. See Schwartz, 799 F.3d at 763. Instead, like the grounds for dismissal in this case, they go to the very heart of bankruptcy's ends: an efficient, orderly, and timely disposition of the debtor's assets in exchange for a discharge from [*17]  debt. Section 707(a)(1) penalizes a debtor's delay that prejudices his creditors, and (a)(3) deals with the debtor's failure to file the most basic of bankruptcy information--how much he owes and how much he has. Subsection (a)(3) targets a particular form of bad faith: the "face sheet" petition, where a debtor files only the minimum amount of information necessary to initiate the automatic stay in order to hinder state-law collection efforts, a long-time weapon of abusive filers. Cf. Charles J. Tabb, The Law of Bankruptcy § 3.16 (3d ed. 2014).

We also reject Krueger's assertion that the lack of an explicit good faith requirement in chapter 7, in contrast to chapters 11 and 13, means that a court cannot dismiss for bad faith. Significantly, the sections in chapters 11 and 13 allowing dismissal "for cause" do not mention good faith or bad faith either, see 11 U.S.C. §§ 1112(b)(1), 1307(c), but this circuit has interpreted good faith as a relevant consideration, see Jacobsen, 609 F.3d at 660. Chapters 11 and 13 both require explicit consideration of good faith to win confirmation of debt repayment plans, but it does not follow that bad faith is irrelevant under chapter 7. See Piazza, 719 F. 3d at 1265 ("[T]here is no basis for [the] assertion that bad faith is immaterial in one chapter simply because it is particularly [*18]  salient in another."). Finally, the Supreme Court has held that bad faith can be the basis of a decision under the Code even if the text does not require its consideration. See Marrama, 549 U.S. at 373-75, 127 S. Ct. at 1110-12. It is incorrect to infer that Congress's silence on good faith in chapter 7 is a license for bad faith debtors to misuse that chapter to their ends. "[G]ood faith . . . is inherent in the purposes of bankruptcy relief" and a "necessary prerequisite[] to obtaining a fresh start." Zick, 931 F.2d at 1129 (quoting McLaughlin v. Jones (In re Jones), 114 B.R. 917, 926 (Bankr. N.D. Ohio 1990)).

Further, this interpretation of § 707(a) does not, as Krueger contends, inaugurate a vast, unprecedented, and unchecked power in the bankruptcy courts. Cf. Marrama, 549 U.S. at 375-76, 127 S. Ct. at 1112 (positing that even without other Code authorization, "the inherent power of every federal court to sanction abusive litigation practices" might have justified the bankruptcy's court's actions (internal quotation marks omitted)). Instead, this court reads § 707(a) to embrace a power that federal courts have long possessed inherently. See Chambers v. NASCO, Inc., 501 U.S. 32, 45, 111 S. Ct. 2123, 2133, 115 L. Ed. 2d 27 (1991).

The automatic stay of actions against a debtor is a potent judicially enforced weapon designed to afford breathing space and a fresh start for the "honest but unfortunate debtor." Grogan v. Garner, 498 U.S. 279, 286-87, 111 S. Ct. 654, 659, 112 L. Ed. 2d 755 (1991) (quoting Local Loan Co. v. Hunt, 292 U.S. 234, 244, 54 S. Ct. 695, 699, 78 L. Ed. 1230 (1934)). That weapon has no place being deployed against honest but unfortunate [*19]  creditors who stand in the path of a dishonest bankrupt. In sum, a debtor's bad faith conduct can constitute "cause" for dismissal under § 707(a).

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