A Refresher On § 1112(b) “Bad Faith” Dismissal For Debtor’s Solvency (In re Dandurand—Part 3)

A time to reflect and refresh (photo by Marilyn Swanson)

It’s helpful, every now and then, to receive a refresher on basic bankruptcy laws.

We have such a refresher — on a creditor’s motion to dismiss for “bad faith,” based on Debtor’s solvency at filing and absence of pre-petition defaults.

The opinion is In re Dandurand, Case No. 24-40401, South Dakota Bankruptcy Court (decided May 23, 2025; Doc. 192).

This article is the third-of-three in a “refresher” series based on the In re Dandurand opinion. The first article is linked here, and the second article is linked here.

What follows is a summary of the In re Dandurand opinion’s discussion of the bad faith dismissal issue.

Facts

Debtor is the sole owner and operator of a Company that manufactures sunflower seeds, kettle potato chips, and pretzels. Company has some tough luck:

a fire burns down Company’s plant — and it takes two years for Company to get its fire insurance money;
Company’s supplier has a listeria outbreak and a national recall — so, Company gets a new supplier but can’t get its products back on the shelves for several years;
then, Company’s potato chip business starts growing rapidly, which creates cash flow problems; and
a year later, Company owes over $800,000 to its new supplier, who is pressuring Company for a pay-down — threatening to cut off further supplies.

Meanwhile, Debtor is dealing with financial stress. As bankruptcy filing approaches:

Debtor cannot pay debts in full when due and is borrowing money to keep debts current; and
Company cuts Debtor’s salary in half, then terminates Debtor’s salary altogether, due to the cyclical nature of Company’s business.

Private Equity firm expresses interest in purchasing Company. Because of increasing financial pressures on Debtor, negotiations begin and result in a Stock Purchase Agreement that would transfer 90% of Debtor’s shares in Company to Private Equity in exchange for $1.00 and other good and valuable consideration.

The Stock Purchase Agreement does not close. So, Private Equity sues Debtor in state court for specific performance.

Then, Debtor files Chapter 11 bankruptcy and moves to reject the Stock Purchase Agreement as an executory contract.

Private Equity objects and responds with a motion to dismiss Debtor’s bankruptcy as a bad faith filing — because Debtor (i) was neither insolvent nor in default on any debts at bankruptcy filing, and (ii) filed bankruptcy solely to stop Private Equity’s lawsuit.

After trial, the Bankruptcy Court (i) grants Debtor’s motion to reject the Stock Purchase Agreement, and (ii) denies Private Equity’s motion to dismiss.

What follows is a summary of the Court’s discussion of the bad faith dismissal issue.

Motion to Dismiss Standards–§ 1112(b)

–Burden of Proof & Judicial Discretion

The burden of proof is on both parties for a motion to dismiss under § 1112(b):

first, the moving party must prove “cause” for dismissal; and
then, the burden shifts to the debtor to produce rebuttable evidence of “unusual circumstances” to avoid dismissal.

What constitutes “cause” is a matter of judicial discretion, to be determined upon the facts of each case.

–Remedy

Once “cause” is found to exist, the Court must choose the remedy under § 1112(b) (i.e., either conversion to Chapter 7 or dismissal), based on “the best interests of creditors and the estate.”

–Bad Faith as Cause

Debtor’s bad faith can be cause for dismissal.

Bad faith includes actions such as concealment, evasion, and direct violations of the Bankruptcy Code or court order that clearly establish an improper motive. Such actions include:

self-dealing and asset manipulation without court approval;
filing frivolous motions or actions to frustrate creditors; and
being unable to reorganize.

There is no single test for identifying a bad faith filing. Instead, courts consider the totality of the circumstances, including debtor’s financial condition, motives, and financial realities.

Other grounds for dismissal as “cause” are identified in §1112(b)(4), such as “substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation.” But Private Equity does not identify (or provide evidence on) any such grounds.

So, the Dandurand opinion focuses exclusively on bad faith allegations in the form of Debtor’s (i) solvency and being current on all debts at bankruptcy filing, and (ii) sole purpose in filing — to stop Private Equity’s state court lawsuit.

Bad Faith Allegations

–Inadmissible Evidence (Rule 408)

Much of Private Equity’s bad faith argument is based on discussions between the parties during pre-petition settlement negotiations. However, such negotiations are not admissible under Fed.R.Evid. 408 — so the Bankruptcy Court does not give weight to those discussions.

–Solvency at Bankruptcy Filing

Private Equity argues that bad faith exists because Debtor was solvent and not in default on any debts at bankruptcy filing. Such argument fails because:

a debtor need not be insolvent to file for bankruptcy protection;
drafters of the Bankruptcy Code understood the need for early access to bankruptcy relief — before debtor is faced with a hopeless situation; and
being solvent and current on debts at bankruptcy filing does not alone establish bad faith.

–Totality of Circumstances

In evaluating bad faith allegations, courts look at all evidence and the totality of circumstances.

Evidence and Findings

Debtor admits that, at bankruptcy filing:

Debtor is not in default on any personal debts;
Company is not in default on any debts, including debts that Debtor personally guarantees;
taxes are current for both Company and Debtor; and
collection efforts by Debtor’s creditors have not yet begun.

Debtor also testifies:

shortly before filing bankruptcy, Debtor takes out substantial personal loans to pay down personal and Company debts;
Debtor has been considering the need for a bankruptcy filing for eighteen months before filing — and consulted with a bankruptcy attorney in June of 2023 before deciding not to file at that time; and
Debtor and Company never recovered from the fire, the listeria recall and related developments, which created a domino effect of financial distress.

The Bankruptcy Court finds:

Debtor’s testimony about finances and financial distress is credible; and
Debtor filed bankruptcy in good faith — because of financial constraints and pressures.

Distinguishing In re Cedar Shore

Private Equity argues that its bad faith argument is supported by this Eighth Circuit precedent in which a bankruptcy is dismissed for bad faith: Cedar Shore Resort, Inc. v. Mueller (In re Cedar Shore Resort, Inc.), 235 F.3d 375 (8th Cir. 2000).

–In re Cedar Shore

In Cedar Shore, shareholders:

file a pre-bankruptcy lawsuit against a solvent and profitable debtor, its officers and management company; and
the lawsuit alleges shareholder oppression, waste, mismanagement, breach of fiduciary duty and tortious interference.

Instead of investigating the claims of the lawsuit, Cedar Shore’s board puts Cedar Shore into bankruptcy and attempts to manipulate the bankruptcy process to achieve a plan that evades the plaintiffs’ claims.

The Cedar Shore bankruptcy is dismissed for bad faith, based upon debtor’s “primary motivation” for filing the bankruptcy: “to dispose of” the pre-petition lawsuit. The dismissal is affirmed on appeal.

–In re Dandurand

The Bankruptcy Court distinguishes In re Dandurand from Cedar Shore like this:

Dandurand faces significant financial pressures before filing bankruptcy (by contrast, the Cedar Shore debtor is both solvent and profitable before filing bankruptcy);
Dandurand makes full disclosures (by contrast, the Cedar Shore debtor fails to disclose $1 million worth of furnishings and equipment); and
Dandurand is trying to maximize value and pay creditors through a bankruptcy plan (by contrast, thee Cedar Shore debtor has no such purpose).

Ruling

Under the totality of circumstances test, the Bankruptcy Court finds in In re Dandurand:

Private Equity did not meet its burden of proof on its bad faith allegations;
Debtor did not file this bankruptcy in bad faith; and
therefore, Private Equity’s motion to dismiss is denied.

Appeal

The Court’s ruling is, of course, on appeal — to the Eighth Circuit Bankruptcy Appellate Panel.

Conclusion

Here’s a “Thank you” to the Dandurand Court for this refresher on allegations of a “bad faith” filing, based on debtor’s solvency and on the absence of loan defaults at bankruptcy filing.

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