NRA Decision Illustrates Vitality of Good Faith Doctrine
When the National Rifle Association filed for bankruptcy in Texas, some pundits speculated that the gun advocates might have been seeking a firearm friendly forum. However, on May 11, 2021, Judge Harlin "Cooter" Hale dismissed the case based on lack of good faith. In re National Rifle Association of America and Sea Girt, LLC, No. 21-30085 (Bankr. N.D. Tex. May 11, 2021). You can find the opinion here. The opinion demonstrates the vitality of the good faith doctrine, which requires debtors’ filings for relief to advance a proper bankruptcy purpose. In the NRA's case, the answer was no.
What Happened
The National Rifle Association is a non-profit company organized under the laws of New York in 1871. In August 2020, the New York Attorney General filed suit to dissolve the NRA, alleging that: (1) the NRA exceeded the authority conferred upon it by New York law, conducted its business in a persistently illegal manner, and abused its powers contrary to the public policy of the state of New York by operating without effective oversight or control by its officers and directors; and (2) the directors or members in control of the NRA looted or wasted the corporate assets, perpetuated the corporation solely for their personal benefit, or otherwise acted in an illegal, oppressive, or fraudulent manner. The NRA perceived this suit as an existential threat to its mission to promote responsible gun ownership and the Second Amendment.
The NRA wanted to escape the jurisdiction of the New York courts which it believed were biased against it. On November 23, 2020, the NRA hired the Neligan Law Firm to advise it on bankruptcy and restructuring options. The next day, it formed Sea Girt, LLC, a subsidiary which it incorporated in Texas. On January 7, 2021, the NRA’s board granted considerable powers to Wayne LaPierre, the entity’s executive vice-president. The board was not told that LaPierre planned to use these powers to file bankruptcy.
On January 15, 2021, Sea Girt, LLC and the National Rifle Association filed Chapter 11 petitions in the United States Bankruptcy Court for the Northern District of Texas. Various creditors cried foul. A long-time donor moved for appointment of a trustee. Ackerman McQueen, one of the NRA’s largest creditors, moved to dismiss or appoint a trustee. The attorneys general of New York and the District of Columbia filed their own motions to dismiss. Sixteen states filed amicus briefs in support of the NRA, as did Texas.
The Court conducted a twelve-day trial beginning on April 5, 2021 and heard from twenty-three witnesses. On May 11, 2021, the Court issued its memorandum opinion granting the motion to dismiss and denying the motions to appoint a trustee or examiner.
The Court’s Ruling
The Court summarized its ruling as follows:
The question the Court is faced with is whether the existential threat facing the NRA is the type of threat that the Bankruptcy Code is meant to protect against. The Court believes it is not. For the reasons stated herein, the Court finds there is cause to dismiss this bankruptcy case as not having been filed in good faith both because it was filed to gain an unfair litigation advantage and because it was filed to avoid a state regulatory scheme.
Opinion, p. 2.
A Detour Into the Meaning of Good Faith
Section 1112(b) of the Bankruptcy Code allows a court to dismiss a chapter 11 case for “cause.” There is a long line of Fifth Circuit cases holding that cause includes filing in bad faith. When a creditor makes a prima facie showing of bad faith, the burden shifts to the debtor to demonstrate good faith. The essence of good faith/bad faith is whether the filing “serves a valid bankruptcy purpose.” Opinion, p. 12.
In the Fifth Circuit, the bad faith doctrine developed largely in the context of single asset real estate filings. In the case of In re Little Creek Dev. Co., 779 F.2d 1068, 1072-73 (5th Cir. 1986), the Court held that it was not bad faith to file a chapter 11 petition to avoid posting a supersedeas bond. The court ruled that good faith was determined by the totality of the circumstances. However, in dicta, the Court included a checklist of factors indicating that a case was filed in bad faith. Unfortunately, these factors defined most single asset real estate filings. While this provided a handy guide for creditors’ lawyers seeking to lift the automatic stay, it did not shed light on the doctrine.
Several years later, the court decided In re Humble Place Joint Venture, 936 F.2d 814, 816-17 (5th Cir. 1991). Humble Place involved a debtor that owned raw land. Its representative made the unfortunate comment that the debtor’s business consisted of mowing the grass and waiting for the market to turn. The Fifth Circuit noted that the primary purpose of the plan was to relieve the guarantors from liability on their guarantees and not to benefit the debtor—an impermissible purpose.
More importantly, the Court gave examples of when a single asset real estate filing (or any other case) might be made in good faith. It stated:
There are several instances in which even one-asset real estate ventures would invoke Chapter 11 in good faith: the asset may be an operating business, like a ranch or a hotel; the development might be nearing the end of construction whose completion would markedly enhance the asset's value; and even a venture including undeveloped property might file to protect true owner equity when market conditions suggest the remedy of a debt restructuring, as opposed to simple liquidation, and the likelihood of prompt resale.
In re Humble Place, 936 F.2d at 818.
The Third Circuit captured the essence of the doctrine when it stated:
A debtor who attempts to garner shelter under the Bankruptcy Code, therefore, must act in conformity with the Code's underlying principles.
Official Comm. of Unsecured Creditors v. Nucor Corp. (In re SGL Carbon Corp.), 200 F.3d 154, 161 (3rd Cir. 1999). Or as stated by Judge Hale, “a Chapter 11 petition is not filed in good faith unless it serves a valid bankruptcy purpose.” Opinion, p. 12.
Why Was the NRA Bankruptcy a Bad Faith Filing?
The NRA’s argument for having a good faith filing was stated in a brief where it said:
The NRA filed for protection under chapter 11 in good faith, not to circumvent judgments in other courts (in fact, no judgments have been rendered), nor to escape an impending trial (because there is none), but because it is in a situation where it must be able to continue its operations in the face of existential threats, in order to maximize the value of its estate and to protect the interests of its members, employees, vendors, and legitimate creditors.
Opinion, p. 16.
So, what was the “existential threat”? Judge Hale found the following testimony from Mr. LaPierre to be illuminating:
Q: Okay. So it comes down to the reason you filed Chapter 11 is because you have this New York attorney general enforcement action which is asking for dissolution of the NRA; is that correct?
[Counsel for the NRA]: Objection; misstates his testimony.
[Counsel for the Movant]: Well --
THE COURT: Well, I’m going to go ahead and let him answer that. Try to give an answer to that, Mr. LaPierre.
THE WITNESS: Yes, Your Honor. Yes, we filed the Chapter 11 to -- because the New York State attorney general is seeking dissolution of the NRA and [seizure of] its assets, and we believe it’s not a fair, level playing field.
. . . .
Q: So really what we’re down to is that it’s -- the New York attorney general action is the reason you believe you need to be in bankruptcy, and, really, solvency and all your other litigation, those are not issues that would require you to be in bankruptcy; is that correct?
A: That’s correct.
Opinion, p. 23.
The Court concluded that obtaining a litigation advantage over the New York Attorney General was not a good faith ground for filing.
(T)he Court believes the NRA’s purpose in filing bankruptcy is less like a traditional bankruptcy case in which a debtor is faced with financial difficulties or a judgment that it cannot satisfy and more like cases in which courts have found bankruptcy was filed to gain an unfair advantage in litigation or to avoid a regulatory scheme. The purpose of this bankruptcy filing may not have been to end the NYAG Enforcement Action immediately, but it was to deprive the NYAG of the remedy of dissolution, which is a distinct litigation advantage… The Court does not know what specific mechanism the NRA plans to use, but its intention is clearly to “take dissolution off the table.”
Opinion, p. 29.
While the NRA may have hoped to find a friendly forum for its gun rights mission in the Lone Star State, this Texas judge found that its justification was all hat and no cattle.
What It Means
My personal hope is that Judge Hale’s decision in National Rifle Associationwill cause practitioners and courts to focus on whether a debtor has a proper bankruptcy purpose and that I will never have to see the Little Creekchecklist again. To summarize some of the lessons from this case:
· Trying to find a favorable venue is not necessarily bad faith;
· Trying to evade a state regulatory scheme is almost certainly bad faith;
· Trying to gain an unfair litigation advantage is almost certainly bad faith; and
· Trying to file bankruptcy when you are not having trouble paying your creditors is almost certainly bad faith.
On the other hand, the quintessential valid bankruptcy purposes are to maximize value and pay creditors. Many years ago, I wrote
In Chapter 11, faith refers to a belief in reorganization. Debtors who are pilgrims on the path to reorganization exhibit good faith; debtors with other purposes or motives display bad faith.
Stephen W. Sather & Adrian M. Overstreet, The Single-Asset Real Estate Debtor: A Selective Overview, 2 J. Bankr. L. & P. 343,358 (July 1993). This was a case where the debtor had other motives or purposes and thus, its bankruptcy case was properly dismissed.
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