The Bad Faith Dismissal In Chapter 11

In re Lake County Grapevine Nursery Operations,  — B.R. —-, 2010 WL 4928488 (Bankr. N.D.Cal.  2011)

In this case, the bankruptcy court denied a motion to dismiss a bankruptcy that the movant alleged was improperly filed.  The case arises out of a dispute involving three entities involved in the cultivation of grapevines in Northern California.  The dispute was resolved in a California state court proceeding.  The Debtor agreed to a large cash settlement, secured by ownership interests in the Debtor.  Roughly three years later, the Debtor filed bankruptcy.

The issue before the court involves a fundamental intersection of corporate law and bankruptcy law.  An entity – that is to say something other than a natural person – cannot act on its own, instead it acts through individuals authorized to act on its behalf.   When a business entity files bankruptcy, the filing must be authorized by the individual who holds the authority to put the business into bankruptcy.   If the individual signing the petition lacks the property authority, then the case must be dismissed.

The movant was the individual who was pledged a controlling interest in the Debtor in the state court settlement.  The movant argued that his security interest gave him control of the Debtor; and therefore, only he could put the Debtor into bankruptcy.  The bankruptcy court held that the pledge of a controlling interest in the Debtor was not self-executing and denied the motion to dismiss.  This was done on the principle that state corporate law determines the allocation of authority within a business entity.

This case not only reiterates that state corporate law has a tremendous effect on a business bankruptcy, but it is also an example of a bankruptcy judge suggesting the ultimate resolution.  In its decision the court made clear that the denial was without prejudice to future motions to dismiss on other grounds.  The court went on to say that it was tempted to dismiss, because the bankruptcy filing was an apparently done to avoid the consequences of the settlement.  Basically the judge said “I may well rule favorably on a motion to dismiss for bad faith.”

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