Opinion ID: 559885
Heading Depth: 2
Heading Rank: 1

Heading: Chapter 11 Filing

Text: 21 Based on Bankruptcy Rule 9011, the bankruptcy court sanctioned Baker for filing a frivolous bankruptcy petition. Rule 9011, which allows a court to impose sanctions on attorneys who assert frivolous claims and defenses in bankruptcy proceedings, provides: 22 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 purpose, such as to harass, to cause delay, or to increase the cost of litigation.... If a document is signed in violation of this 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. 23 This rule parallels Federal Rule of Civil Procedure 11, containing only such modifications as are appropriate in bankruptcy matters. Cinema Serv. Corp. v. Edbee Corp., 774 F.2d 584, 585 (3d Cir.1985). Accordingly, our review of the lower courts' application of Rule 9011 is informed by Rule 11 jurisprudence. 24 As in Rule 11 cases, we review the imposition of sanctions pursuant to Bankruptcy Rule 9011 using the abuse of discretion standard. See Cooter & Gell v. Hartmarx Corp., --- U.S. ----, 110 S.Ct. 2447, 110 L.Ed.2d 359 (1990); Mareno v. Rowe, 910 F.2d 1043 (2d Cir.1990), cert. denied, --- U.S. ----, 111 S.Ct. 681, 112 L.Ed.2d 673 (1991). We are mindful, however, that legal errors on the part of the [lower courts] will constitute an abuse of discretion. Mareno, 910 F.2d at 1047. 25 In order to impose a Rule 9011 sanction, a bankruptcy court must find that an attorney has submitted a claim that has no chance of success under existing precedents and that fails to advance a reasonable argument to extend, modify or reverse the law as it stands. Id.; see also Securities Indus. Ass'n v. Clarke, 898 F.2d 318, 321 (2d Cir.1990). Essentially, the court may sanction on the basis of Rule 9011 if an attorney advances a frivolous argument. 26 A petition for Chapter 11 bankruptcy may be deemed frivolous if it is clear that on the filing date there was no reasonable likelihood that the debtor intended to reorganize and no reasonable probability that it would eventually emerge from bankruptcy proceedings. See, e.g., Carolin Corp. v. Miller, 886 F.2d 693, 698-702 (4th Cir.1989); In re Coffee Cupboard, Inc., 119 B.R. 14, 17-18 (E.D.N.Y.1990); In re Marion Street Partnership, 108 B.R. 218, 223 (Bankr.D.Minn.1989). Generally, courts should conclude that a debtor has no demonstrable intent to reorganize only if, upon considering the totality of the circumstances, there is substantial evidence to indicate that the debtor made a bad faith filing. See 5 C. King, Collier on Bankruptcy Sec. 1112.03, at 112-33 (15th ed. 1989) (Collier ). Here, the bankruptcy court, finding that Cohoes' primary reason for filing the Chapter 11 petition was to impede LSA's attempt to reacquire possession of the Sparrowbush apartment complex, concluded that Cohoes did not have a genuine intent to emerge from bankruptcy as a rejuvinated organization. Therefore, pursuant to Rule 9011, it sanctioned Baker for filing a frivolous petition on Cohoes' behalf. 27 Baker concedes that one of Cohoes' reasons for filing the petition was to attack collaterally the state court default judgment as unconstitutional and, consequently, stay LSA's execution of the default judgment. However, he argues that it was legitimate for Cohoes, a corporation in financial difficulty, to resort to the bankruptcy court to challenge the constitutionality of a judgment rendered against it, as well as to obtain a respite from creditor demands and attempt to reorganize. We agree. 28 Filing a bankruptcy petition with the intent to frustrate creditors does not by itself establish an absence of intent to seek rehabilitation. Banque de Financement, S.A. v. First National Bank, 568 F.2d 911, 917 (2d Cir.1977). Indeed, because a major purpose behind our bankruptcy laws is to afford a debtor some breathing room from creditors, it is almost inevitable that creditors will, in some sense, be frustrated when their debtor files a bankruptcy petition. See, e.g., In re Food Workshop, Inc., 70 B.R. 962, 967 n. 3 (Bankr.S.D.N.Y.1987). In reality, there is a considerable gap between delaying creditors, even secured creditors, on the eve of foreclosure and the concept of abuse of judicial purpose. Collier Sec. 1112.03, at 1112-33. 29 Although LSA's attempt to execute the state court judgment was delayed by Cohoes' collateral attack, it cannot be held that the collateral attack was unfounded. A bankruptcy court, like any federal court, may entertain a collateral attack on a state court judgment. See Kelleran v. Andrijevic, 825 F.2d 692, 694 (2d Cir.1987), cert. denied, 484 U.S. 1007, 108 S.Ct. 701, 98 L.Ed.2d 652 (1988). However, because bankruptcy filings must be made in good faith, an entity may not file a petition for reorganization which is solely designed to attack a judgment collaterally--the debtor must have some intention of reorganizing. See generally Carolin Corp., 886 F.2d at 698-702. Although a debtor need not be in extremis in order to file such a petition, it must, at least, face such financial difficulty that, if it did not file at that time, it could anticipate the need to file in the future. See, e.g., In re Johns Manville Corp., 36 B.R. 727 (Bankr.S.D.N.Y.1984). In this case, it is clear that Cohoes was encountering financial stress at the time it filed its petition: it had recently lost the primary tenant of its major property; it had been ordered by New York State to build a sewer connection on its property which would cost between $125,000 and $250,000; it needed a new roof on its building which had an estimated cost of $150,000 to $300,000; it was in arrears on rental and mortgage payments; and it was indebted to suppliers. Certainly this is enough to support Cohoes' Chapter 11 filing and its subsequent application to the court to consider its collateral attack. 30 It is also clear that a collateral attack on the state court default judgment was available to Cohoes. On appeal, the New York courts based their denial of Cohoes' motion to vacate the default judgment on procedural grounds. Because Cohoes' constitutional attack on the propriety of service was never addressed by the New York courts, a collateral attack remained open to Cohoes in the bankruptcy court. 31 Moreover, it is equally apparent that Cohoes had a plausible basis on which to premise its collateral attack. A default judgment is vulnerable to a collateral attack if the court rendering the judgment does not have proper jurisdiction over the action. See Kalb v. Feuerstein, 308 U.S. 433, 438-39, 60 S.Ct. 343, 345-46, 84 L.Ed. 370 (1940). In this case, Cohoes challenged the constitutionality of the state court default judgment rendered against it, arguing that in the state action, LSA failed to effect service in a manner that was reasonably calculated to notify Cohoes. See Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306, 314, 70 S.Ct. 652, 657, 94 L.Ed. 865 (1950). Cohoes did not contest that service was effected in accordance with New York's Business Corporation Law Sec. 306. Nor did it challenge the constitutionality of the section itself. Instead, it argued that because LSA knew that the Secretary of State, on whom service was made, had forwarded the summons and complaint to Cohoes' former address, LSA's choice of alternative service was not reasonably designed to apprise Cohoes of the pendency of the proceeding and was thus improper. Moreover, Cohoes contended that even though it learned of the action through other channels, LSA was nevertheless required to effect constitutional service on Cohoes. See City of New York v. New York, N.H. & H. Ry. Co., 344 U.S. 293, 296, 73 S.Ct. 299, 301, 97 L.Ed. 333 (1953). Since personal jurisdiction over a litigant cannot constitutionally be obtained if service is improper, Cohoes argued that the judgment itself was invalid. See, e.g., Robinson v. Hanrahan, 409 U.S. 38, 40, 93 S.Ct. 30, 31, 34 L.Ed.2d 47 (1972) (holding that service regarding state foreclosure proceedings sent to the last known address of a prisoner was not reasonably calculated to reach the prisoner when the State knew that the prisoner was not at the address to which the notice was mailed). Although we do not address the merits of Cohoes' jurisdictional argument, it is evident that there existed a reasonable basis on which to attack collaterally the default judgment in the bankruptcy court. 32 In any event, it seems clear from Cohoes' actions following the filing that it did not file the petition with the sole intent of delaying execution of the state court judgment. While the initiation of Chapter 11 proceedings did stave off LSA's execution of the judgment for several months, the bankruptcy court eventually determined that the state court judgment was res judicata and directed Cohoes to relinquish possession of the apartment complex. At that point, Cohoes did not seek to convert the proceeding to Chapter 7; nor did it move to dismiss the petition. See 11 U.S.C. Sec. 1112 (1988) (providing for voluntary dismissal or conversion to Chapter 7 on application or motion of the debtor). Rather, it continued in its attempt to reorganize. 33 In concluding that the Chapter 11 petition was frivolous, the bankruptcy court emphasized that at the time the petition was filed, Cohoes had no secured creditors and only three unsecured creditors that were unrelated to it. Further, the court noted that at the time of the filing, Cohoes no longer held any property that was in danger of being forfeited as a result of creditor pressure. Despite these conclusions, the bankruptcy court did not grant the United States Trustee's motion to dismiss the petition; nor did it subsequently dismiss the petition sua sponte. Rather, the court appointed a Chapter 11 trustee to oversee the reorganization. Although the court later converted the action to a Chapter 7 proceeding--which according to LSA indicates the court's belief in the petition's frivolity--it thereafter reconverted the action to Chapter 11. Because bankruptcy courts readily dismiss Chapter 11 petitions that are brought in bad faith, see, e.g., Carolin Corp., 886 F.2d 693; In re Little Creek Dev. Co., 779 F.2d 1068 (5th Cir.1986); In re Madison Hotel Assoc., 749 F.2d 410 (7th Cir.1984); Banque de Financement, 568 F.2d at 917, the court's initial decision not to dismiss the Chapter 11 petition, as well as its subsequent decision to reconvert the case to Chapter 11, strongly indicate that the petition itself had some valid basis in law. Indeed, we believe that a court may not ordinarily consider a Chapter 11 bankruptcy petition to be frivolously filed if the court itself previously rejected a motion to dismiss the petition. 34 It should also be noted that LSA failed to move for dismissal of the debtor's Chapter 11 petition and instead joined in the motion to appoint a Chapter 11 trustee. If LSA believed that Cohoes would not eventually reorganize, LSA would have--or indeed should have--joined in the United States Trustee's motion to dismiss the petition. In fact, LSA admits that continuation of the Chapter 11 proceeding was advantageous to it, because the proceeding afforded it a convenient forum to litigate claims. Consequently, we find that LSA, a party that never moved to dismiss the Chapter 11 case or otherwise alerted the court to the purported frivolity of the petition, is estopped from asserting that the Chapter 11 petition was frivolously filed. 35 Our basic view is that the petition could not have been deemed frivolous at the time it was filed and therefore we conclude that the bankruptcy court abused its discretion by imposing sanctions on this basis. 36