Bad Faith Dismissals in Bankruptcy, Part 1: Chapter 7 Debtors with Primarily Non-Consumer or Business Debts

When a debtor files for bankruptcy, a creditor may be able to seek dismissal of the bankruptcy if the petition was filed in bad faith. This article will provide an overview of the options available to a creditor if a debtor with primarily business debts files for Chapter 7 bankruptcy.

What is a Bad Faith Filing in Bankruptcy?

A bad faith filing is one that is inconsistent with the purposes of bankruptcy or is an abuse of the bankruptcy system. However, the requirements and criteria for a successful dismissal depend on the chapter and type of debt. For example, in Chapter 7, a debtor with primarily consumer debts must satisfy the requirements of Section 707(b) of the Bankruptcy Code, while a debtor with primarily non-consumer debts, or business debts, could face dismissal based on Section 707(a).

How Do I Know If a Debtor Has Primarily Business Debts?

To determine which requirements are applicable to a Chapter 7 debtor, it’s important to determine whether the debtor has primarily business debts or consumer debts. Usually, the debtor will indicate whether the debts are primarily business debts or consumer debts in his petition and schedules filed with the bankruptcy court. However, much more stringent requirements apply to consumer debtors, so occasionally, a debtor will inaccurately classify the type of debts to avoid these requirements. It’s important to know the difference between each to be able to spot if a debtor has incorrectly classified its debts.

Section 101(8) of the Bankruptcy Code defines “consumer debt” as debts “incurred by an individual primarily for a personal, family, or household purpose.” For purposes of Chapter 7, debtors who are not “individuals” with “primarily” consumer debts qualify as non-consumer debtors and are subject to 707(a). “Primarily” has been construed by courts to mean a “majority” of debts.

This definition has left many to wonder what exactly a “majority” of debts means – is it the majority of the total amount of debt? Or the majority of the number of debts owed? For example, if a debtor lists 5 debts on the bankruptcy petition, 4 consumer debts and 1 business debt, does that mean the majority of the debts are consumer debts? What if the total debt owed is $100,000 and that 1 business debt is $90,000?

The Eleventh Circuit has not provided any further explanation for how to determine if a debtor has primarily consumer debts. However, courts may look to the Tenth Circuit, which clarified that primarily consumer debt means consumer debt exceeding 50% of the total debt. See In re Stewart, 175 F.3d 796 (10th Cir. 1999). It’s important to ensure the debtor has properly classified the debts before proceeding with any attempt to dismiss in bad faith, as it will determine what a creditor needs to be on the lookout for.

When Will a Business Debtor’s Chapter 7 Bankruptcy Be Dismissed for Bad Faith?

If a debtor has adequately shown it qualifies as a debtor with primarily business debts, Section 707(a) of the Bankruptcy Code applies. Section 707(a) provides that a bankruptcy court may dismiss a bankruptcy case, after a notice and hearing, for cause. The Bankruptcy Code provides 3 examples of cause: (1) an unreasonable delay by the debtor, (2) nonpayment of any fees or charges required by the Bankruptcy Code, and (3) failing to provide required documents to the trustee. 11 U.S.C. § 707(a).

However, “cause” for dismissal is not limited to these examples; the court may dismiss for any other reason it finds constitutes cause. The Eleventh Circuit has held that bad faith constitutes cause under 707(a). See In re Piazza, 719 F.3d 1253 (11th Cir. 2013). The standard for a finding of bad faith is determined based on the facts of each individual case, rather than any set test or method. However, courts have found relevant indicators of bad faith to include:

• The debtor is filing to avoid one large single debt or to evade one creditor
• The debtor has filed incomplete or inaccurate financial schedules
• The debtor filed at a time that suggests an intent to delay or frustrate creditors
• The debtor has sufficient resources to pay debts
• The debtor has not attempted to repay debts
• The bankruptcy is essentially a two-party dispute

Not any one of these factors is enough, by itself, to warrant dismissal for bad faith. The bankruptcy court must examine the totality of the circumstances and all relevant facts to find the debtor has filed in bad faith. However, in instances when one or more indications of bad faith are present, a dismissal for bad faith under 707(a) is a powerful option for creditors seeking to recover repayment.

Conclusion

A dismissal of bad faith is a highly fact-specific inquiry, requiring a determination of which Bankruptcy Code provisions are applicable and whether the facts of a specific case indicate a debtor has acted in bad faith. However, filing a motion for dismissal is a powerful protection for creditors who believe a debtor may have filed in bad faith. When dealing with such a fact-specific analysis, its important to consult with an attorney with experience and knowledge in bankruptcy law to ensure the proper steps are taken to ensure a creditor’s opportunity to recoup from the debtor is maximized, without violating any additional bankruptcy rules.

Related blogs:
Bad Faith Dismissals in Bankruptcy, Part 2: Chapter 7 Debtors with Primarily Consumer Debts | Jimerson Birr (jimersonfirm.com)