Weathering the Storm: Eleventh Circuit Vacates Four-Year-Old 363 Sale Order Based on Bad Faith Filing of an Involuntary Bankruptcy Case

09/16/2014

On August 15, 2014, the Eleventh Circuit entered a Memorandum Opinion in the Wortley v. Chrispus Venture Capital, LLC case (In re Global Energies, LLC, “Global”)1 unwinding a section 363 sale order entered in 2010 by the Bankruptcy Court for the Southern District of Florida based on a finding of bad faith in the filing of an involuntary bankruptcy case in 2010. The Wortley opinion identifies a new risk for buyers of distressed assets in a bankruptcy case to consider if they were petitioning creditors (or petitioning equity owners) of the Chapter 11 debtor - the potential reversal of a sale order years after the closing of the transaction. The motivation of the petitioning creditors in filing the involuntary bankruptcy petition is of significant import in the ultimate ruling of the Court.

Global was owned by Joseph Wortley, James Juranitch and Chrispus Venture Capital, LLC (“Chrispus”). In early 2010, the relationship of Global’s owners became strained. On July 1, 2010, Chrispus filed an involuntary petition against Global initiating the Global bankruptcy case. The involuntary bankruptcy filing was the result of a plan by two of Global’s equity owners (Chrispus and Juranitch) to take control of Global from Wortley. Chrispus and Juranitch evidenced this scheme by non-privileged emails exchanged between them on June 17-19, 2010.

After the involuntary petition was filed, a Chapter 11 trustee was appointed in the case. The trustee then sold the assets of Global to Chrispus pursuant to section 363 of the Bankruptcy Code. The Bankruptcy Court’s order approving the sale contained standard section 363(m) good faith findings in favor of Chrispus, the buyer.

While Wortley consented to the appointment of the Chapter 11 trustee, he subsequently sought dismissal of the bankruptcy case, arguing that the case was not filed in good faith and was instead an effort by Chrispus and Juranitch to squeeze him out of his ownership position. Despite Wortley’s discovery requests on these issues, the other equity owners improperly withheld the June 17-19 emails documenting the scheme to acquire Global’s assets through the involuntary filing. Further, the owners testified that there was no plan or communications regarding Chrispus’s decision to file the involuntary bankruptcy case against Global. Based on the lack of direct evidence to support Wortley’s bad faith arguments, he withdrew his motion to dismiss without prejudice. Between the time when Wortley filed his motion to dismiss and withdrew it, the trustee sold Global’s assets to Chrispus, and the Bankruptcy Court approved the sale.

Subsequently, after the one-year deadline to seek reconsideration of the sale order had passed, Wortley renewed the motion to dismiss.2 This motion was denied. Thereafter, Wortley obtained the improperly withheld June 17-19 emails demonstrating that Chrispus and Juranitch had indeed colluded to use the involuntary filing to “eradicate” Wortley’s investment in the company and gave false testimony about the scheme. After obtaining these emails, Wortley timely sought reconsideration of the Bankruptcy Court’s denial of his motion to dismiss under Rule 60(b) of the Federal Rules of Civil Procedure citing newly discovered evidence that demonstrated the bad faith filing of the bankruptcy case. The Bankruptcy Court summarily denied the motion and decided that no remedy was available to Wortley. On appeal, the District Court affirmed and reasoned that Wortley’s new evidence was insufficient to warrant Rule 60(b) relief. Wortley appealed these decisions to the Eleventh Circuit.

On appeal, the Eleventh Circuit reversed the lower courts and ruled that the Bankruptcy Court clearly erred in not granting the motion to reconsider and dismissing the case based on the clear evidence that the case was filed in bad faith.3 The Circuit Court remanded the case to the Bankruptcy Court to grant Wortley’s Rule 60(b) motion, to set aside the sale of Global’s assets to Chrispus, and to conduct hearings to determine the scope and amount of sanctions and orders that should be entered against Chrispus and the other colluding parties who abused the bankruptcy process.

The opinion does not directly address the propriety of the sale order - or the section 363(m) protections accorded under the Bankruptcy Court’s sale order.4 The decision to unwind the sale was solely based on the finding that Chrispus had filed the involuntary petition in bad faith and, but for the improper withholding of evidence, including the giving of false testimony, the Bankruptcy Court “could and should have” dismissed the case, or, “[a]lternatively, could have revisited the Global sale.” In its decision the Court ruled that the vacatur of the sale order “should be without prejudice to any innocent third parties, whose rights and interests are derived and dependent upon the sale.”

While the Wortley opinion clearly provides that a finding of “bad faith” with respect to the filing of a bankruptcy case can result in its dismissal years after filing, it is unclear whether the holding requires the unwinding of all sales that transpired prior to dismissal of a bankruptcy case subsequently deemed to have been filed in bad faith. As a general matter, a dismissal for a bad-faith filing is a matter of court discretion under section 1112(b) - not a matter of jurisdiction. Section 349(b) of the Bankruptcy Code (and its accompanying legislative history) seems to provide that dismissals are not per se intended to unwind sales to good faith purchasers in a bankruptcy case.5 Accordingly, it can be argued that the Wortley holding should be limited to circumstances in which the purchaser is also the party found to have unclean hands with respect to the debtor’s bankruptcy filing. This is especially true because of the egregious conduct of the parties and possibly some of their counsel in concealing the true motivation for filing the case and concealing the documents and other evidence in discovery.

Until case law clarifies the instances in which a sale may be unwound based on a subsequent determination of a bad faith filing, the Wortley decision will likely cause third-party purchasers in bankruptcy sales to investigate the motives of the bankruptcy filing in determining the risks in acquiring assets out of a Chapter 11 bankruptcy. This evaluation is especially important to the buyer of the assets if the buyer was a petitioning creditor (or owner) seeking involuntary bankruptcy relief. The holding should further cause parties to ownership disputes to reconsider initiating an involuntary case as a mechanism to resolve the dispute. Finally, the decision should serve as a reminder to all parties to honestly and completely comply with all discovery obligations and to carefully consider not evidencing and sharing their litigation strategy in non-privileged communications.

For more information, please contact:

Lenard M. Parkins
212.659.4966
lenard.parkins@haynesboone.com

 

Karl D. Burrer
713.547.2231
karl.burrer@haynesboone.com

 

Judith Elkin
212.659.4968
judith.elkin@haynesboone.com

 

Trevor Hoffmann
212.659.4993
trevor.hoffmann@haynesboone.com

Kenric D. Kattner
713.547.2518
kenric.kattner@haynesboone.com

Stephen M. Pezanosky
817.347.6601
stephen.pezanosky@haynesboone.com

 

 

Ian T. Peck
214.651.5155
ian.peck@haynesboone.com 

 

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1 No. 13-11666, 2014 WL 3974577 (11th Cir. Aug. 15, 2014)
2 In support of the renewed motion to dismiss, Wortley cited to the newly produced emails evidencing the other owners’ intent to cut Wortley out of the business but not discussing the filing of the involuntary petition.
3 The Circuit Court found that the case should have been dismissed for bad faith under all three recognized tests for a bad faith bankruptcy filing: (i) the improper purpose test, where a creditor files a bankruptcy petition deliberately to gain advantage in a business dispute, (ii) the improper use test, where a creditor uses bankruptcy to accomplish objectives not intended by the Bankruptcy Code, such as taking over a debtor corporation or its assets, and (iii) under the test modeled on Rule 9011 of the Federal Rules of Bankruptcy Procedure.
4 Section 363(m) protects a good faith purchaser from any modification of the sale terms (absent a stay pending appeal).
5 The legislative history provides, in pertinent part, “[t]he basic purpose of the subsection is to undo the bankruptcy case, as far as practicable, and to restore all property rights to the position in which they were found at the commencement of the case. This does not necessarily encompass undoing sales of property from the estate to a good faith purchaser.”

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