The bad debtor | Nelson Mullins Riley & Scarborough LLP

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The law is the witness and the outer deposit of our moral life. Its history is the history of the moral development of the race.

Olivier Wendell Holmes

Bankruptcy law decisions are replete with references to the “worthy debtor”. In re Carp340 F.3d 15, 25 (1st Cir. 2003); In re BankVest Capital Corp., 360 F.3d 291 (1st Cir.2004); In re Institute of Business and Professional Educ., Inv., 79 BR 948 (Bankr. SD Fla. 1987); In re Nickerson40 BR 693 (Bankr. ND Tex. 1984); In re Marble(Bankr. WD Tex. 1984); In the Doherty case, 219 BR 665 (Bankr. WDNY 1998).

These decisions generally employ the nomenclature of “good debtor” in the context of the rights granted by the provisions of the Bankruptcy Code. It is always the “worthy debtor” who has the right to a debt forgiveness, to a “fresh start”, or to refuse cumbersome contracts. This usage speaks to a universe that also contains the “unworthy debtor”, a party whose behavior does not merit the statutory blessings of the Bankruptcy Code. The identity of these parties is most often examined in the context of the discharge of debts and the behavior or actions that justify a refusal to discharge or the finding that a particular debt is not dischargeable.

There is a larger and more amorphous question which also merits consideration, namely, are their industries, corporations, enterprises whose function and purpose are so odious and incompatible with the precepts of good citizenship and the “moral development of race”, to quote Justice Holmes, that they should be denied the benefits of reorganization offered by the Bankruptcy Code.

If there is any argument to be made to prevent these companies from enjoying the benefits of the Bankruptcy Code, to deny them the familiar label of “worthy debtor”, that remedy probably falls under the provisions of the Bankruptcy Code which require that a plan for the reorganization be “proposed in good faith and not prohibited by law”. 11 USC § 1129(a)(3). The “not prohibited by law” requirement is of limited use in situations where the behavior is recognizably immoral or inherently wrong for the most part, but has not yet been sanctioned by any legislative authority. In particular, and perhaps conversely, businesses engaged in the sale and cultivation of cannabis do not have access to the Bankruptcy Code because they are acting in violation of the federal Controlled Substances Act, 21 USC §§ 801 and following, which takes precedence over state laws authorizing the sale of cannabis. See, Gonzales vs. Raich, 545 US 1, 12 (2005). Accordingly, since bankruptcy is a creature of federal law, cannabis cases are generally dismissed out of hand for cause pursuant to 11 USC § 1112(b) and do not meet the standard of confirmation. See, Regarding Way To Grow, Inc.., 597 BR 111 (Bankr. D. Col. 2018).

If “prohibited by law” is not available as a source of relief, the last best hope of preventing sanctioned reorganization of the unworthy debtor lies in the requirement that a plan be offered in “good faith”.

“Good faith” is not defined by the Bankruptcy Code, making it more likely that our understanding of good faith may be transitory and that as the “moral development of the race” progresses, our understanding of “good faith” could also be. ‘ In other words, what was good faith yesterday might not be good faith today, in light of our community experience and our growth as citizens.

First, we can understand from the order of the words within s. 1129(a)(3) that the good faith standard exists independently of the “prohibited by law” standard. A plan of reorganization may describe a course of action that is not prohibited by law, but nevertheless may not meet the “good faith” standard.

The good faith standard as used in section 1129(a)(3) is most often described as proposing a plan that fulfills the purposes and objectives of the Bankruptcy Code. These aims and objectives in the context of Chapter 11 are most often understood to be “to prevent a debtor from going into liquidation, with attendant loss of jobs and possible misuse of economic resources.” NLRB vs. Bildisco & Bildisco465 US 513, 528 (1983); see also, Bank of Am. Nat. Confidence & Savings. Ass’n c. 203 N. LaSalle St. P’ship526 US 434, 452 (1999) (“[T]he two recognized policies underpinning Chapter 11 [are] maintaining business continuity and maximizing assets available to satisfy creditors”)

This case law, which is by far the most consistent use of the term, focuses on reimbursing creditors and preserving an ongoing business. It does not suggest the existence of anything more amorphous beyond these standards and it supports the idea that the “good faith” standard is not meant to be an existential inquiry into the moral value of a particular industry.

Bankruptcy courts have recognized, however, that the absence of a definition of good faith leaves courts without “precise formulas or measures to deploy in a mechanical equation of good faith”. Metro Emp. Credit Union v. Okoreeh–Baah (In re Okoreeh–Baah), 836 F.2d 1030, 1033–34 (6th Cir. 1988) (interpreting good faith in the context of chapter 13).

Any successful collateral attack under s. 1129(a)(3) against the “good faith” of the immoral enterprise must likely follow the path of linking the good faith standard to the “public good.” Bankruptcy courts have invoked the “public good” in refusing to perform certain contracts and have followed the precepts of some courts that “while breaches of public order must be determined by ‘specific indications in the law of sovereignty,” courts should not be shy about striking down agreements that tend to harm the public good or contravene an established social interest. Stamford Bd. de l’Educ. against Stamford Educ. Ass’n.697 F.2d 70, 73 (2d Cir. 1982).

The concept of “public good” is no stranger to bankruptcy courts. Seeking relief for debtors who are the sole providers of a service in their geographic area is an immensely easier task, no court or bankruptcy judge likes to see a business fail and when the business is important to the community, bench reorganization support often works to facilitate reorganization. Bankruptcy courts, although limited by statute, are in practice courts of equity. Using these fair arguments to support a reorganization is both feasible and a reality of current practice.

Whether fair arguments can be used conversely to graft a sense of “public good” onto the good faith requirement of s. 1129(a)(3) is decidedly uncertain and not directly supported by the case law as it exists.

Somewhere out there, however, in one of those little frontier towns between the squares of unelected legislators and the judicious and novel application of historical precedent, is the “moral development of the race” and the court of bankruptcy which concludes that it is incumbent on the concept of good faith just consideration of the public good.

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