Involuntary Bankruptcy Filing By Debtor’s Owner/Creditor Is In Good Faith (In re Global Energies—Cert. Denied)

By: Donald L Swanson

Is an involuntary bankruptcy, filed by an owner/creditor of the Debtor, filed in good faith or in bad faith?

That’s the question before the U.S. Supreme Court on which it denied certiorari on October 30, 2023 (Wortley v. Juranitch, Case No. 23-211).

Here’s the gist of the case.

• Three owners (Joe, Jim and Rick) of a failing business can’t get along: Joe and Jim are fighting, and Rick is trying to make peace.
• Rick’s peace efforts fail, and the owners are at an impasse because no one has enough voting leverage to break through, file bankruptcy, or do anything else.
• So, Rick wants to protect his investment in the business, which includes a $1 million loan.  Since Rick can’t do anything through his ownership voting rights, he decides to put the business into involuntary Chapter 11 bankruptcy, using his $1 million loan.
• Rick files the involuntary bankruptcy on July 1, 2010 (yes, that’s right, >13 years ago).
• Lots of machinations by the owners ensue, within the bankruptcy, which includes various appeals on a variety of issues.
• Joe opposes the involuntary bankruptcy on a variety of grounds and moves to dismiss the case as filed in bad faith.  Joe contends that the bankruptcy filing is for the improper purpose of “breaking a deadlock” and getting a “business divorce” among owners.
• Litigation ensues.  Lots of it . . . and over a very long time.
• Rulings are made.  Appeals are taken.  And the case comes back before the Bankruptcy Court on remand. 

Long story short from there:

• Bankruptcy Court denies Joe’s dismissal motion on June 25, 2018, in a 70 page “Final Order on Remand”;
• U.S. District Court for the Southern District of Florida affirms on appeal;
• Eleventh Circuit Court of Appeals also affirms; and
• then, U.S. Supreme Court denies certiorari.

What follows is a summary of the:

• messy facts involved; and
• legal standards the Bankruptcy Court applies in ruling that the involuntary bankruptcy is filed in good faith.[Fn. 1]

Facts

Joe and Jim are very good friends, confidants and golf partners. Joe is also a friend of Rick.  Joe brings the three of them together to form Global Energies.  Later, the friendships end and jeopardize the business.

Based on evidence at trial, the Bankruptcy Court finds that Joe and his “personal animosity and rancor” towards Jim and Rick are the problem: that Joe’s animus has fueled this case “far beyond the rational stopping point of a traditional bankruptcy case.”

–Forming Global Energies

On July 14, 2008, Joe and Jim form Global Energies:

• Joe owns 23% for contributing $23,000.00 in initial capital;
• Jim owns 77% for contributing his intellectual property rights—an invention entitled “Recycling and reburning Carbon Dioxide in an energy efficient way” and his “research and development work and intellectual property rights” in the field of production of biofuels and/or capturing carbon dioxide; and
• Joe is the business guy, Jim is the technical guy, and both loan money to the business.

In May 2009, Rick invests in Global Energies at Joe’s invitation and gets a 5% ownership, which reduces Joe’s share to 32% and Jim’s share to 63%.

Rick also loans Global Energies $1 million at 6% interest—but Rick has no say in management of the business.  Such management rests with Joe and Jim, but neither can do anything without the agreement of the other—because a 75% majority vote is required to take any significant action, and the combined shares of Jim and Rick do not reach that 75% level.

–Potential for Increased Value Never Realized.

Between May 2009 and May 2010, Global Energies has multiple potentially-lucrative project opportunities—e.g.:

• projects in North Carolina and Iowa, for turning waste into energy;
• a proposal to open three 750 million plants; and
• Jim declares the potential profit numbers to be “staggering.”

Although Joe, Jim and Rick believe Global Energies to be a valuable investment, Global Energies has no concrete value on paper. Global Energies:

• does not own any patents;
• has no revenue in 2008, 2009, or 2010; 
• has a negative cash flow;
• needs a cash infusion because it has no cash in its bank accounts;
• cannot pay its bills or Jim’s salary; and
• uses $50,000 of Rick’s money to pay bills.

Despite such problems, both Joe and Rick want to increase their ownership interests—and Joe tries to renegotiate the ownership division.

–Breakup: Jim’s Testimony.

On May 12, 2010, Joe is upset because he isn’t getting enough information about Global Energies from Jim—even though Joe has received the same monthly reports that others involved with Global Energies receive.

That same day, Joe presents Jim with a proposed contract for Joe to purchase 270,000 shares from Jim (which would give Joe a controlling interest) for “$10 and other valuable consideration.”

Joe even commands Jim to sign the proposed contract “immediately” and without consulting an attorney.  And Joe threatens “dire consequences,” if Jim refuses to sign or discusses the proposal with Rick.  Such consequences include Joe cutting off all credit cards, all insurance, all payroll . . . so that the business “wouldn’t be funded.”

Jim refuses to sign because he wants time to consider the contract and contact an attorney.

The following day, Joe arrives at Global Energies’ facilities, removes Jim from a business meeting, and insists that Jim sign the proposed contract—reiterating the same threats from the day before.

Jim provides the same response of wanting to consult an attorney before signing—and Joe again insists upon an immediate signing without benefit of counsel. When Jim walks away, without signing, Joe follows and screams that he will turn off all credit cards and shut down the company funding. 

Jim believes that Joe is melting down and will carry out the threats. So, Jim is worried about Global Energies and its employees—recalling how Joe previously bragged about “trying to force his will on another company he was involved in” and locking out all its employees.

Jim is worried about being locked out of the Global Energies facility, because he keeps a large amount of personal property there — enough to fill “a 4800 square foot warehouse,” including items he inherited from his recently deceased father.

On that same day, Jim informs the employees that something is “desperately wrong” and that they need to “get their personal stuff out.”  Jim also requests their help in removing his own personal items—which they help him do.

Later, Jim discovers that the doors to the Global Energies facility are locked and that his keys don’t work.

–Breakup: Joe’s Testimony.

Joe’s testimony about the same circumstances are similar—but paints Joe in a more favorable light.

Joe is upset with Jim about project priorities and about being uniformed. What Joe wants is a change in the ownership distribution: believing that Rick is entitled to more and Jim is entitled to less, since one of the deals failed to pan out.

Joe, knowing that Global Energies needs a cash infusion, demands that Jim sign over “a significant portion of his equity’ until certain conditions re met.”  That would give Joe a controlling interest in Global Energies—but Jim refuses to sign.

Then, Joe gives Jim an ultimatum: either sign over a significant portion of your equity in exchange for continued financing, or “tell me what the heck is going on.” Joe says that, after being presented with the demand and ultimatum, Jim “stormed out.”

The next morning, Joe feels that he must get a further understanding with Jim, so he visits Jim at the Deerfield office.  Joe describes Jim as “belligerent” at this time, and Joe tells Jim, “Don’t spend any money until you tell me what’s happening.”

Later, when Joe visits the Deerfield Office, he discovers that stuff is gone: that Jim had taken a lot of Global assets from the building to parts unknown, had taken all of the employees to parts unknown, and had refused to meet and discuss.  So, Joe says, “I wanted him to come back.” Joe believes that Jim has a fiduciary duty to “come and talk” with him.

But instead, Jim moved out of the Deerfield Office and took all of the company.  So, Joe changes the locks at the Deerfield Office and cuts off the company credit cards, until Jim comes back to the table.

The result is that Jim refuses to work with Joe anymore, and Joe fails to reopen the locks or reinstate the credit cards—even when Jim comes back to the table during negotiations.

Also, Joe believes that Rick is taking Jim’s side and that Jim and Rick are operating Global Energies from afar. Joe acknowledges that Global Energies is deadlocked.

–Credibility

In evaluating conflicts in testimony given by Jim and Joe, the Court refuses to give any weight to Joe’s version because the Court finds Joe’s testimony to lack credibility.

–Rick Steps In

During the blowup between Joe and Jim, Rick is out of the country—in France.

Rick learns of the blowup by an email from Joe, which admits that Joe has turned off the money “until issues resolved” and warns that Jim “may try to run to you in order that he can seek approval of his foolish ways . . . please let me know if he cries to you.” In another email, Joe adds that Jim has “absconded” with Global Energies’ assets “to parts unknown.”

Then, Jim sends an email to Rick saying, “Joe has gone through a major melt down that has put your investment at great risk.”

Meanwhile, Jim works to keep Global Energies afloat and maintain progress on projects in Iowa and Wisconsin, and Rick joins those efforts. Rick understands that Joe and Jim are not getting along, but the details he is hearing from Joe don’t add up to the drastic steps Joe has taken.  Such steps are putting Rick’s million dollar investment in jeopardy.

Upon Rick’s return to the States, he meets with Joe—who accuses Jim of improperly charging personal expenses to Global Energies.  Joe authorizes Rick to investigate. Then, Joe leaves the for a two weeks family vacation in the Bahamas.

So, Rick gets Jim’s side of the story. Then Rick emails Joe, describing how Rick is “caught in a food fight between two supposed adult businessmen.” Joe responds with, “let Jim stew in the mess he created.”  This response does not sit well with Rick, who is concerned about Global Energies’ employees, believing it is wrong “to throw them out on the streets.”

Rick does not know whom to trust (Joe or Jim) and is confused about what has happened.  Rick even suspects that Joe and Jim may be “in cahoots” to harm him.  Though Rick and Joe are good friends, Rick is adamant about not taking sides.

As authorized by Joe, Rick conducts an investigation to determine which party — Joe or Jim — is being truthful. Rick discovers:

• Jim did charge personal expenses to Global Energies; but
• those expenses are offset by payroll deductions; and Global Energies actually owes money to Jim.

Rick also discovers:

• a $48,000 payment from Global Energies to one of Joe’s companies; and
• concludes that Joe misappropriated those $48,000 of company funds.

So, Rick emails Joe to:

• report on the $48,000 missing funds;
• explain that those funds, had they not been misappropriated, would have been enough to forestall the financial problems that ensued;
• opine that Joe’s $48,000 misappropriation “killed the company”; and
• demand Rick’s million-dollar investment back. 

–Reorganization Attempt

Then, Rick attempts to mediate a deal between Joe and Jim.

Additionally, Rick retains bankruptcy counsel to evaluate bankruptcy options for the company.  Rick’s bankruptcy counsel advises that:

• bankruptcy is a viable option for Global Energies because of the management deadlock and because its closure prevents operation outside of bankruptcy;
• Global Energies’ Operating Agreement prevents a voluntary filing because it required Joe and Jim to agree for any such action to be taken; and
• Rick can file an involuntary bankruptcy against Global Energies because of Rick’s undisputed million-dollar loan and because all other involuntary filing requirements are satisfied.

Rick’s bankruptcy counsel recommends that the involuntary petition seek a Chapter 11 proceeding, instead of a Chapter 7 proceeding, because Chapter 11 will satisfy Rick’s objective of saving the business.

Before filing the involuntary petition, Rick presents three separate settlement proposals to Joe and Jim: 

• The first is for Jim to buy out Joe—Joe rejects this offer;
• The second is to “split the baby” (i.e., to divide the business assets and operations between Joe and Jim)—Joe rejects this offer as well; and
• The third is to (i) replace Joe in management with a person Joe selects, and (ii) realign ownership shares based on new contributions of capital (Rick is willing to put in “a lot more money”)—Joe is upset by the realignment idea and does not respond.   

So, Rick files the involuntary petition against Global Energies.  He tells Joe that the bankruptcy is filed “due to the significant impasse created by the existing operating agreement, and the close down of all operations of Global Energies, and the apparent lack of willingness to restructure.”

After the bankruptcy filing, Rick continues to mediate between Jim and Joe, explaining that “the involuntary bankruptcy petition will remain in place until such time as an agreement is reached.” Joe shuts down negotiations by saying, “as long as you are trying to extort me with the bogus Federal Court action, I see no reason to meet with you.” And so, negotiation efforts fail and the deadlock persists.

Each party blames the other for the deadlock.  And Rick declares, “You two guys [Joe and Jim] screwed it up.” But neither Joe nor Jim blames Rick or the bankruptcy filing for breakup of the company.

–Global Energies has No Value at Bankruptcy Filing.

Joe’s expert testifies at trial that the value of Global Energies is $70 million and that Joe’s share of the company is worth $20 million.

The Court disregards this valuation as unreliable, speculative, irrelevant, and based on bias and prejudice.  The Court notes, for example, that Joes’ expert witness:

• believed the breakup events between Joe and Jim left valuation unaffected;
• admitted that his valuation is speculative;
• based the valuation on a hypothetical merger with another company—even though such merger never occurred, never moved past the speculative state, and was rejected by Rick;
• assumed that Global Energies has “access to the technology,” even though Global Energies does not have any such thing;
• did not know how many patents Global Energies owned, never conducted a patent search, and would not normally do such a search for a technology company valuation.
• failed to consider the objectives of the other two investors (Rick and Jim);
• failed to consider the decision-making impasse;
• did not know about the management deadlock, when preparing the expert report;
• demonstrated a bias in favor of Joe, a long-time friend, and prejudice against Jim and Rick;
• held a proposal from Joe to do investment banker work for Global Energies when the bankruptcy is dismissed;
• had a personal interest in the proposed merger;
• based his opinion, in part, on “the bad acts” of Jim and Rick;
• assumed that the bankruptcy was filed in bad faith; and
• incorrectly believed that Jim’s interest in Global Energies was taken away from Jim by the bankruptcy.

Further, the Court finds the “most salient portion” of the expert’s testimony is his admission that the value of Global Energies is zero, if operations are shut down after the managing members’ breakup.  The reality is that, as of the bankruptcy filing date:

• Global Energies’ operations are shut down;
• the managing members are deadlocked;
• Global Energies does not have ownership of or access to the necessary technology;
• Global Energies has no capital or cash;
• none of the parties were willing to invest additional capital; and
• Global Energies had never merged with another entity.

So, the Court finds that the value of Global Energies, at the time of the bankruptcy filing, is zero.

–Rick had Good Faith Purposes for Filing the Involuntary.

Rick testified consistently on a proper purpose for the bankruptcy filing:

• to get Global Energies “into a position where we could move on and do something with it, and reorganize it, restructure it”;
• to “restructure Global and keep it going”;
• “I still hadn’t given up on trying to put this thing back together”;
• “Restructure, reorganize it, get it going”;
• “We tried to resurrect it”; and
• “The farther we went on, the more problems we were having in terms of ever seeing Global come back, but we didn’t want to give up on it quite yet.”

Rick engaged bankruptcy counsel “to look into bankruptcy, because the company was dead, and broke, and so we had to figure out what to do with it.” Rick did not know much about bankruptcy (including the difference between Chapter 7 and 11 bankruptcies), and he “had nothing to do with that kind of decision” about the technical aspects of filing a bankruptcy case.

Rick never intended to remove Joe from Global Energies through the bankruptcy, testifying:

• Q. Did you have a “plan to get rid of me?”
• A. “No, not at all. Not at all . . . . You’re my friend, you got me into this.”

Joe insists, by contrast:

• the “petition was not filed because of payments to creditors. It was filed only because they couldn’t get me to restructure the way they wanted to”;
• Jim “had agreed with certain of the negotiation proposals,” but “I did not agree with any of the proposals”;
• “I would not change the stock ownership,” so “they filed an involuntary”; and
• Rick “was using the bankruptcy to get Jim back to the table.”

The initial bankruptcy filings allege that Global Energies is “generally not paying such debtor’s debts as they become due” and “the Board and Members are deadlocked and cannot manage Global Energies.”  Such allegations are supported by the evidence as valid reasons for the bankruptcy filing.

Legal Standards

–Dismissal for Bad Faith.

Under 11 U.S.C. § 1112(b)(1), “on request of a party in interest, . . . the court shall . . . dismiss a case . . . for cause.”

In the Eleventh Circuit, there is no particular test for determining whether a petition is filed in bad faith.  Instead, a court’s determination of “cause” under § 1112(b):

• is subject to judicial discretion under the circumstances of each case; and
• may be based on any factors which show an intent:
  • to abuse the judicial process and the purposes of the reorganization provisions; or
  • to delay or frustrate the legitimate efforts of secured creditors to enforce their rights.

–A “Non-exhaustive” Factors Test

The Eleventh Circuit provides the following non-exhaustive factors as a guide for deciding whether bad faith exists, which factors are “not to be rigidly applied”:

1. Debtor has only one asset, in which it does not hold legal title;
2. Debtor has few unsecured creditors;
3. Unsecured creditors’ claims are small in relation to the claims of secured creditors;
4. Debtor has few employees;
5. Debtor’s property is the subject of a foreclosure action as a result of arrearages on the debt;
6. Debtor’s financial problems are essentially a dispute between the Debtor and secured creditors which can be resolved in a pending state court action; and
7. Timing of the bankruptcy filing evidences an intent to delay or frustrate the legitimate efforts of the Debtor’s secured creditors to enforce their rights.

Additionally, a finding that “there is no realistic possibility of an effective reorganization” would support the conclusion that the debtor seeks merely to delay or frustrate the legitimate efforts.

–Three More Tests

The Eleventh Circuit also provides three more tests for bad faith:

1. Improper purpose test—bad faith exists when the filing of the petition is motivated by ill will, malice or the purpose of embarrassing or harassing the debtor;
2. Improper use test—bad faith exists when a creditor uses a bankruptcy proceeding to accomplish objectives not intended by the Bankruptcy Code, such as taking over a debtor corporation and its assets; and
3. Test modeled on Rule 9011 of the Federal Rules of Bankruptcy Procedure—bad faith exists, when a filing party, (1) fails to make a reasonable inquiry into the facts and the law before filing, and (2) files the petition for an improper purpose.

–Common Theme

All tests for bad faith seek to determine whether the following exist:

• an honest intention; and
• a real need and ability to effectuate the aim of reorganization, including a total liquidation of  debtor’s assets.

The Tests Applied

Here, the Court finds no evidence that the involuntary Chapter 11 bankruptcy was filed in bad faith under any of the Eleventh Circuit’s tests. Instead, the Court finds that the primary purpose in filing the involuntary petition is to reorganize Global Energies and resolve the deadlock between the primary members.

The Court bases this finding on the facts as a whole, especially the following:

• Rick files the involuntary petition under Chapter 11 of the Bankruptcy Code (rather than under Chapter 7);
• Rick testifies that he wants to reorganize Global Energies, keep Joe involved, and make Joe whole;
• Rick attempts to resolve the deadlock between Joe and Jim—both before and after the bankruptcy filing; and
• Rick’s communications with Joe, Jim and others, reveal an intent to reorganize.

–Non-Exhaustive Factors Test

It is true that some of the non-exhaustive factors are established by the evidence. As of the bankruptcy filing date, Global Energies:

• does not own any patents;
• has very few tangible assets;
• has few employees;
• has few unsecured creditors, with claims smaller than the secured creditor’s; and
• has, as its primary financial problem, a dispute between Global Energies and Rick, a secured creditor.

However, the Court:

• emphasizes the “non-exhaustive” nature of the factors and that those factors are “not to be rigidly applied”;
• finds no evidence of an intent to abuse the judicial process or to delay or frustrate the legitimate efforts of the secured creditors;
• finds that Rick, a secured creditor, files the involuntary petition for the proper purposes of reorganizing Global Energies and resolving the owners’ deadlock, for the benefit of the creditors and other parties;
• recognizes Rick’s altruistic intent of ensuring that Debtor’s employees are paid in full; and
• recognizes that Rick subordinates his own claim to ensure claims of all other creditors, including Joe, are paid in full.

Such actions show that Rick acted with a proper intent: to utilize the judicial process for the benefit of the creditors, and not to abuse the process or delay or frustrate their rights. The Court finds Joe’s contrary testimony to lack credibility.

–Improper Purpose Test

Rick testifies credibly, the Court finds, that the purpose of the bankruptcy filing is to reorganize and resolve the owners’ deadlock. Such testimony shows that Rick:

• was not “motivated by ill will, malice or the purpose of embarrassing or harassing” Global Energies; and
• had a proper intent—to reorganize or resurrect Global Energies after the breakup between Joe and Jim.

The Court finds Joe’s contrary testimony to lack credibility.

–Improper Use Test

In this bankruptcy, Rick moves immediately for the appointment of a Chapter 11 trustee and does not seek to have himself named as the trustee. Further, Rick has no need to attempt a takeover of Global Energies because Global Energies had a value of zero at the time of bankruptcy filing.

Based on the evidence, the Court finds no bad faith under the improper use test. The Court finds Joe’s contrary testimony to lack credibility.

–Test Modeled on Rule 9011.

Rick conducted a thorough examination of Global Energies’ books and records with the assistance of a forensic accountant. And Rick and the forensic accounted consulted the advice of counsel prior to filing the bankruptcy.

The Court finds this investigation and the use of an attorney to be more than reasonable inquiry into the facts and law before filing the bankruptcy. Additionally, Rick did not file for an improper purpose, as the Court has already found.

So, the Court finds no bad faith under the Rule 9011 test. The Court finds Joe’s contrary testimony to lack credibility.

–Court’s Conclusion

All evidence and legal tests considered, Rick’s involuntary bankruptcy filing against Global Energies is supported by:

• the “presence of an honest intention and a real need and ability on the part of the debtor to effectuate the aim of reorganization, even if this involves a total liquidation of the debtor’s assets”;
• a deadlock among Global Energies’ managing-members (especially Joe), for which the Operating Agreement provided no relief;
• a decision to resolve the deadlock by filing involuntary bankruptcy—a decision made by Rick, a member of Global Energies with no management authority, in the hope of reorganizing Global Energies;
• an “honest intention” held by Rick; and
• a “real need and ability” to reorganize Global energies, even if the ultimate result is “total liquidation.”

Accordingly, the Court concludes that the involuntary bankruptcy petition was not filed in bad faith but was filed, instead, in good faith: for the proper purpose of reorganizing Global Energies, which is necessitated by the deadlock between managing members.

Conclusion

Finding good faith v. bad faith in a bankruptcy filing can be difficult.

The appellate-approved and certiorari-denied Global Energies decision, summarized above, provides a helpful guide for making the good faith v. bad faith filing distinction—in a messy and hotly contested case.

———————-

Footnote 1.  The summaries of facts and legal analysis are taken from the Bankruptcy Court’s 70 page “Final Order on Remand” entered on June 25, 2018, as Doc. 1063, from In re Global Energies, LLC, Case No. 10-28935 in the Southern Florida Bankruptcy Court. 

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