Opinion
No. 91-5049 MBM
October 8, 1992
Claudia C. Conway, Butler, Fitzgerald Potter, New York, New York, co-attorney for appellants.
Marc. A. Beilonson, Buchalter, Nemer, Fields, Younger, Los Angeles, California, co-attorney for appellants.
Bruce H. Roswick, New York, New York, attorney for the collateral trustee.
Dennis O'Grady and Bruce T. Roepe, Riker, Danzig, Scherer, Hyland Perretti, Morristown, New Jersey, co-attorneys for appellee.
A. Dennis Terrell, Robert F. Malone, and Susan M. Wortman, Shanley Fisher, New York, New York, attorneys for appellee.
Opinion
Petitioners-Appellants, LNC Investments, Inc., Charter National Life Insurance Company, and Magten Asset Management Corporation appeal orders of the Bankruptcy Court for the Southern District of New York (i) requiring that appellants post a $10 million bond pursuant to 11 U.S.C. § 303(i)(2) in order to proceed with their Chapter 11 petition for involuntary bankruptcy relief against the Secured Equipment Trust of Eastern Airlines, Inc., as putative debtor, and (ii) dismissing appellants' petition for failure to post that bond. For the reasons set forth below, the orders appealed from are reversed and the case is remanded for further proceedings consistent with this opinion.
I.
The Secured Equipment Trust ("the Trust"), which appears to have been created as a financing device for Eastern, exists pursuant to an agreement dated November 15, 1986 — the Secured Equipment and Lease Agreement — between First Fidelity Bank, National Association, New Jersey, as indenture trustee, and Eastern. (D2 Ex. A) Under the Trust Indenture ("the Indenture"), First Fidelity issued and sold to the public three series of trust certificates in the aggregate face amount of $500 million. (Id. § 2.01) Appellants hold second and third series trust certificates aggregating $54.17 million (D1)
"D" connotes a document from the record below designated for inclusion in the record on appeal.
On February 18, 1987, the Indenture was amended (D2 Ex. B); under that Second Supplemental Indenture, First Fidelity was appointed Collateral Trustee. In addition, a trustee was appointed to represent each series of trust certificate holders:
(1) Midlantic National Bank was appointed First Series Trustee;
(2) United Jersey Bank was appointed Second Series Trustee; and
(3) Connecticut National Bank was appointed Third Series Trustee.
(Id. § 2.01)
Pursuant to the Indenture, the Trust paid the proceeds from the sale of the trust certificates to Eastern in exchange for ownership of a fleet of Eastern's commercial passenger jets. (Id. Ex. A § 3.01) Those planes were collateral for the trust certificates. Moreover, Eastern unconditionally guaranteed the trust certificates. (Id. § 2.03(d))
The Indenture also obligated the Trust to lease its aircraft back to Eastern, "until such time as Eastern satisfied all its rental obligations under the Indenture, which consisted of making payments of principal, premium (if any) and interest on all outstanding Secured Equipment Certificates, and payment of the fees and expenses of the Collateral Trustee and Series Trustee[s]." (Id. ¶ 7 and Ex. A §§ 4.01, 4.02)
The Indenture directed the Collateral Trustee to collect rental payments from Eastern and to distribute them to the holders of the three series of trust certificates according to the priority established by the Indenture. (Id. Ex. A §§ 3.09, 9.04, 12.01) However, the Collateral Trustee was obligated to distribute only those rental payments Eastern actually made. (Id. § 2.03 at 25, 30, 40) In addition, as provided in the Indenture and the trust certificates, the first, second, and third series trust certificates mature, respectively, on November 15, 1993, November 15, 1996, and November 15, 2001. (Id. § 2.02)
Eastern made timely rental payments to the Trust until March 9, 1989, when Eastern filed a voluntary petition for relief under Chapter 11, 11 U.S.C. § 1101 et seq., in the United States Bankruptcy Court for the Southern District of New York. Eastern made one timely post-petition rental payment on May 15, 1989, but has defaulted on all subsequent rental payments. (D20 at 10) Nonetheless, until Eastern ceased operations on January 19, 1991, it continued to use the Trust's fleet of planes.
At time that Eastern filed for bankruptcy, trust certificates with an aggregate face amount of $454 million were outstanding as follows: $188 million of first series certificates, $169 million of second series certificates, and $97 million of third series certificates. (D4 at 4)
On or about January 23, 1991, Martin Shugrue, Eastern's Chapter 11 trustee, and the Trust entered into a stipulation, which the Eastern bankruptcy court approved, pursuant to which Eastern agreed to turn over to the Trust (i) the Trust's aircraft fleet and (ii) an escrow account of approximately $230 million that had been generated by Eastern's sale and lease of Trust aircraft. (D4 at 4-5)
On January 24, 1991, pursuant to the January 23 stipulation, the Trust became obligated to maintain and market the Trust fleet; the Trust also was authorized to sell or lease any or all of its airplanes to third parties. (D4 Ex. E at 9) On January 28, 1991, Eastern turned over to the Trust the $230 million escrow account. (D20 at 33) Since January 24, 1991, the Trust has sold nine of its jets to Delta Air Lines, and has leased 14 of its jets to Pan American Airways. (D7 at 3)
For five weeks following Eastern's surrender of the escrow account, the Collateral Trustee did nothing with those funds except pay certain maintenance and marketing expenses. On February 7, 1991, the First Series Trustee wrote the Collateral Trustee, demanding that the Collateral Trustee distribute to the first series certificate holders that portion of the escrow account necessary to pay principal, accrued interest, interest on that interest, and early redemption premiums. (D2 at 6 and Ex. D) The Collateral Trustee made no such distributions.
On March 4, 1991, the Second Series Trustee also wrote the Collateral Trustee demanding that the Collateral Trustee pay the first series certificate holders only the principal, but presumably not the interest or other charges, owed on their certificates. (Id.) The Collateral Trustee still did not distribute any of the escrow funds to the certificate holders.
Instead, on March 7, 1991, the Collateral Trustee started an adversary proceeding before the Eastern bankruptcy court, seeking guidance as to distribution of the escrow funds. (Id. Ex. E) The First and Second Series Trustees filed answers to the Complaint. (D4 at 6 and Ex. D) On April 11, the Collateral Trustee moved for summary judgment; the court scheduled a hearing on that on motion for April 23, 1991. (D4 at 8 and Ex. E) As of the hearing date, Eastern and the Third Series Trustee had not filed answers because they contended that the petition in the case at hand, which had been filed on March 28, 1991, stayed the adversary proceeding. (D19 at 6)
However, at a May 2, 1991 status conference in the adversary proceeding, the court ruled that to the extent the involuntary petition stayed the adversary proceeding, that stay would be vacated to permit the filing of responsive pleadings. (Id. at 20) At the time of the status conference, the Third Series Trustee had not filed an answer but did so the next day; Eastern also had not filed an answer and did not file one until May 14, 1991. (D20 at 187)
The principal issue posed by the adversary proceeding is whether the Eastern bankruptcy halted accrual of interest on the trust certificates. The First Series Trustee has taken the position that interest has continued to accrue; the Second Series Trustee has not taken a position; the Third Series Trustee has taken the position that interest ceased accruing on the date Eastern filed its petition for relief; and Eastern has taken the position that interest ceased accruing on January 28, 1991, when it surrendered the Trust's fleet and escrow account. (D4 Ex. C, D)
If interest did continue to accrue, a negative interest spread would exist because the Collateral Trustee invested the escrow funds in short term United States Treasury Obligations earning 5.5% to 6% while the three series of trust certificates pay 11.75%, 12.75%, and 13.75% annual interest respectively. (D20 at 12)
On March 28, 1991, prior to the hearing in the adversary proceeding, appellants filed the involuntary petition at issue, in the United States Bankruptcy Court for the District of New Jersey, seeking relief pursuant to 11 U.S.C. § 303. On April 22, 1991, the Resolution Trust Corporation, which holds $20 million of second series trust certificates and $15.5 million of third series, joined LNC Investments and Charter National Life. (D6)
On April 24, 1991, in response to the Collateral Trustee's application to dismiss or transfer the case, the Bankruptcy Court for the District of New Jersey entered an order transferring the case to the United States Bankruptcy Court for the Southern District of New York (Lifland, C.J.). (D10)
On May 10, 1991, on the application of the First Series Trustee, Judge Lifland held a hearing to determine whether to require appellants to post a bond pursuant to 11 U.S.C. § 303(e) pending resolution of the Collateral Trustee's motion to dismiss. (D20) The Collateral Trustee and the First Series Trustee argued that if the petition were dismissed, the Trust would be entitled to an award equal to the alleged "negative interest spread" that accrued during the pendency of the involuntary petition. (D14 at 8-9; D20 at 10-11) According to the Collateral Trustee's calculation, which included compounded interest on past-due interest, the negative interest spread was accruing at an approximate rate of $133,333 per day. (D20 at 12) In contrast, Eastern calculated that the negative interest spread was accruing, if it was accruing at all, at a rate of $122,437.02 per day. (D20 at 34) Appellants claim that both these calculations are exaggerated because they are based on the interest costs tied to the full $453 million outstanding trust certificates rather than interest costs associated with the Collateral Trustee's failure to retire $230 million worth of Trust certificates. (Appellant Mem. at 11 n. 9)
At the hearing, the Collateral Trustee also submitted evidence allegedly showing that appellants had filed their involuntary petition for relief in bad faith. That evidence was the transcript of a tape recording of an April 5, 1991 conference call among officers of a number of companies holding second series trust certificates, including David Sherman, a vice president of Charter National Life Insurance Company. (D20 at 121) During the April 5 conference call, Sherman stated:
MR. SHERMAN: [One reason for the filing is that the First Series certificate holders are seeking payment of] interest on interest and redemption premium if entitled to it. And they have been very strongful [sic] with that way. And as a result if that were to happen there would be no cash left in the estate for the Second or the Thirds to take care of their planes and generate asset sales or even help upkeep their lease requirements. So that was one.
Two, the structure between the Indenture Trustees and the Collateral Trustee, as Barbara has experienced, is horrible. The Collateral Trustee really won't do anything if he can avoid it because he is afraid of getting sued. And the Indenture Trustees say we think you should do this but we're not going to instruct you. So no one . . . nothing ever gets done. If Northwest or some other firm came to the Collateral Trustee and said we can sell you, we can sell 20 planes tomorrow, we'll by them, but it's a one week offer and you have to decide, the Collateral Trustee would say "Gee, I don't know. What should I do." The Firsts would say "We don't care as long as we can get our cash out." The Seconds would probably say "as Long as it's relatively reasonable price we should do this because we could hopefully get our cash out." The Thirds would be objecting because they won't be satisfied in today's market prices because, you know, they figure they get wiped out.
. . .
The structure is really poorly set up and if this was a real bankruptcy we would have a Creditors Committee and if there were any internal disputes a judge would resolve them and the three Indenture Trustees wouldn't be involved at all except in an ex-officio manner. And the Collateral Trustee would be the Debtor. And frankly we thought it was important to get the people with the economic stakes in the decision making process and get rid of these middle people who don't have to listen to us at all unless we get 50% together and then we still need two out of the three. So that was the primary reason for filing.
Two, it is our intention, if the bankruptcy was upheld, . . . or if no one challenges it, to appoint a Trustee that everyone can agree on that is a business person where Aeron or whoever else if you weren't satisfied with Aeron would continue in a consulting role but would be a business person to run it. And the reason we like this is that we think all the Indenture Trustees and the Collateral Trustee have a conflict because they are all facing lawsuits and two, they're just not business people. I mean, you know, these guys can't do anything. It would be our intention to set it up so there would be a Trustee who would represent the Debtor and there would be a Creditors Committee. We would go forth and hopefully there would be some kind of reorganization plan that would help eliminate these intercompany problems and in essence reach a settlement through a reorganization plan that everybody could live with. And it could be relatively short since it is mainly resolving those disputes and the Court could expedite the matter.
MS. LUBOW: Doesn't this really belong in a Chapter VII liquidation if it belongs in bankruptcy? There is no reorganization. There's no business.
* * * * *
MR. SHERMAN: As far as why we think we can file it, we think that it is a business trust. If you read the Indenture very closely there was a Trust set up. There is a Trustee nominated that runs the Trust. It does make decisions regarding selling planes, entering into leases, etc. They do hold title to their planes. And we went through all the points . . . . Will it survive if it gets challenged? I don't know. I think you are treading on new law. And I think we will either win or lose and it could go either way. We don't have a strong sense whether we win or lose. We do think we could lose if it was challenged. But we don't think it's a slam dunk either way. It takes a lot of educating a judge which is an uphill battle for the filers but we certainly think it has real legal merit. We didn't just do this without thinking about it. We spent a great deal of time thinking about it.
(D21 at 1-4) (ellipses in original)
The Bankruptcy Court reserved decision on the merits of appellants' claim until a hearing scheduled for June 13, 1991. However, the court tentatively concluded that the Trust did not qualify as a business trust, and thus was ineligible for Chapter 11 relief. (D20 at 168-71)
The Bankruptcy Court also held that the Collateral Trustee had proved a prima facie case of appellants' bad faith in filing the petition for involuntary relief, finding that appellants' "essential purpose" in filing was "advancement of intercreditor interests," not implementation of a reorganization plan. (D20 at 172-73) Therefore, the Bankruptcy Court required appellants to post a $10 million bond by 5:00 p.m. on May 15, 1991, in order to proceed with their petition. (D20 at 174-750) Petitioners did not post the bond and the Bankruptcy Court dismissed the petition on May 23, 1991. (D24)
II.
Appellants argue that the Bankruptcy Court's order requiring them to post a $10 million bond, which was based on the Bankruptcy Court's finding that appellants had filed their petition in bad faith, resulted from that court's application of an incorrect legal standard — namely, an incorrect measure of bad faith. On appeal, "a district court may not set aside a bankruptcy court's finding[s] of fact, unless those findings are clearly erroneous." United States Fidelity Guar. Co. v. DJF Realty Suppliers, Inc., 58 B.R. 1008, 1010 (N.D.N.Y. 1986) (emphasis omitted). However, "findings of fact [that] are based on an incorrect legal standard improperly applied . . . are subject to plenary review . . . ."Id.
Although it did not state specifically what standard it was applying, that Bankruptcy Court explained its finding that appellants had filed their involuntary petition in bad faith as follows:
And I find that there is sufficient in this record to support a prima facie finding that the filing was not calculated to achieve a reorganization under Title 11, but rather for the advancement of practical intercreditor interests.
Certainly, a reorganization, if this was an eligible Debtor, does have attractive features to it that could possibly deal with many of the anomalies that have now occurred by virtue of the fact that here are so many shortfall, both in the Trust amongst the creditors, beneficiaries of the trust causing many, many problems and tension. But I do believe that this particular Trust was never contemplated to be the subject of any involuntary petition.
With respect to the filing of a petition and considerations of bad faith, most interestingly the Court of Appeals on May 1st, last week, has handed down a decision in this Circuit in the matter of Cohoes Industrial Terminal, Inc., decided May 1, 1991, . . . where the Court comments upon filings of bankruptcy petitions and the concept of bad faith, the goal of the filing.
. . .
But as I have already indicated, I do find sufficient in this record to support the prima facie finding that the filing was not calculated to achieve a reorganization and for what the essential purposes of a filing were.
(D20 at 172-73)
Accordingly, in order to proceed with their petition, the Bankruptcy Court required appellants to post a $10 million bond pursuant to 11 U.S.C. § 303(e). Section 303(e) provides that: "After notice and a hearing, and for cause, the court may require petitioners under this section to file a bond to indemnify the debtor for such amounts as the court may later allow under subsection (i) of this section."
In turn, § 303(i) provides:
If the court dismisses a petition under this section other than on consent of all petitioners and the debtor, and if the debtor does not waive the right to judgement under this subsection, the court may grant judgment —
(1) against the petitioners and in favor of the debtor for —
(A) costs;
(B) a reasonable attorney's fee; or
(2) against any petitioner that filed the petition in bad faith, for —
(A) any damages proximately cause by such filing; or
(B) punitive damages.
11 U.S.C. § 303(i) (emphasis added).
Section 303(i)'s bonding requirement is designed to "discourage frivolous petitions as well as the more dangerous spiteful petitions, based on a desire to embarrass the debtor . . . or to put the debtor out of business without good cause . . . ." H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 323 (1977); see also In re Reed, 11 B.R. 755, 757 (Bankr.S.D.W. Va. 1981). However, a "bond should not routinely be required of petitioners on request of a debtor" because the Bankruptcy Code "does not impose a mandatory bond requirement." In re Reed, 11 B.R. at 757.
Moreover, "It is clear that there is a presumption of good faith in favor of the petitioning creditor, and thus the alleged debtor has the burden of proving bad faith." United States Fidelity Guar., 58 B.R. at 1011. Therefore, although the parties and research have disclosed no case directly addressing the issue, it appears that the putative debtor must establish a prima facie case of bad faith before petitioning creditors may be required to post a bond under § 303(i)(2). See In re Contemporary Mission, Inc., No. 5-82-00916, slip op. (Bankr.D.Conn. Jan. 31, 1983) ("[T]he determination of whether to require a bond should not be turned into a de facto hearing on the merits; instead, the involuntary petition's lack of merit must be relatively clear." (quoting Norton Bankruptcy Law and Practice § 9.12 at 27 (1981))); cf. Cohoes Indus. Terminal, Inc. v. Latham Sparrowbush Assoc. (In re Cohoes Indus. Terminal Inc.), 931 F.2d 222, 227 (2d Cir. 1991) (court must find "substantial evidence" of bad faith before imposing sanctions for bad-faith filing).
In the case at hand, the bankruptcy judge's finding of bad faith appears to have been premised on his determination that appellants' primary motivation for filing their involuntary petition was the resolution of intercreditor disputes rather than the confirmation of a Chapter 11 reorganization plan. On appeal, appellants argue that such a finding is insufficient to establish bad faith under § 303(i)(2). Instead, they argue, the bankruptcy judge's determination should have been governed by the Second Circuit recent decision in In re Cohoes Indus. Terminal, Inc., supra. However, I need not determine whetherCohoes, which addressed Bankruptcy Rule 9011, the bankruptcy analog of Fed.R.Civ.P. 11, establishes the appropriate standard of bad faith under § 303(i)(2), nor choose among alternative definitions of what that standard is. The Bankruptcy Court's finding that appellees had established a prima facie case of bad faith is clearly erroneous under any of the various § 303(i)(2) standards of bad faith thus far adopted by courts. See, e.g., In re Fox Island Square Partnership, 106 B.R. 962, 967 (Bankr.N.D.Ill. 1989) (combined objective/subjective bad faith test); In re Petralex Stainless, Ltd., 78 B.R. 738, 743 (Bankr.E.D.Pa. 1987) (same); In re Midwest Processing Co., 41 B.R. 90, 102 (Bankr. N.D. 1984) (objective bad faith test); Basin Elec. Power Coop. v. Midwest Processing Co., 47 B.R. 903, 909 (N.D. 1984), aff'd, 769 F.2d 483 (8th Cir. 1985), cert. denied, 474 U.S. 1083 (1986) (subjective bad faith test); In re Nordbrock, 772 F.2d 397, 399 (8th Cir. 1985) (improper use test); In re Salmon, 128 B.R. 313, 315 (Bankr.M.D.Fla. 1991) (improper purpose test).
Rule 9011 provides:
The signature of an attorney or a party [on a document submitted to the court] constitutes a certificate that the attorney or party has read the document; that to the best of the attorney's or party's knowledge, information, and belief formed after reasonable inquiry it is well-grounded in fact and is warranted by existing law or a good faith argument for the extension, modification, or reversal of existing law; and that it is not interposed for any improper purposes, such as to harass, to cause delay, or to increase the cost of litigation . . . . If a document is signed in violation of the rule, the court on motion or on its own initiative, shall impose on the person who signed it, the represented party, or both, an appropriate sanction, which may include an order to pay to the other party or parties the amount of the reasonable expenses incurred because of the filing of the document, including a reasonable attorney's fee.
Appellees proffered no evidence of appellants' bad faith in filing their petition. To support its finding that appellants had filed their petition in bad faith, the Bankruptcy Court relied on statements by Sherman during the April 5 conference call about the possibility that filing involuntary petition would help resolve intercreditor disputes. (See D20 at 172-73; D21 at 1-4) However, evidence of appellants' desire to resolve those disputes through a bankruptcy proceeding does not show that appellants filed their petition in bad faith; so long as appellants did not file their petition solely to gain settlement leverage — and there is no evidence of that — the resolution of intercreditor disputes through a plan of reorganization is an entirely legitimate goal of bankruptcy proceedings.
Indeed, if the transcript of the April 5 telephone conference, on which the Bankruptcy Court based its finding that appellants had filed their involuntary petition in bad faith, proves anything relevant, it is that appellants filed their petition in good faith. Specifically, that transcript shows that, before filing their petition, appellants carefully considered the legal bases for their petition, and decided that reasonable arguments supported their petition. In addition, the Bankruptcy Court's own finding that reorganization had "attractive features" for appellants (D20 at 172-73) virtually negates that court's finding of bad faith.
In sum, there is no evidence that the petition was objectively baseless — i.e., that reorganization was impossible, or that it was subjectively improper in the sense of having been motivated by a desire to use the bankruptcy proceeding to achieve a forbidden or even a suspect result or effect. Accordingly, the orders of the Bankruptcy Court (i) requiring appellants to post a $10 million bond pursuant to § 303(i)(2), and (ii) dismissing appellants' involuntary petition as a result of their failure to post that bond are vacated, and the action is remanded to the Bankruptcy Court for further proceedings consistent with this opinion.
SO ORDERED: