Bad Faith in Filing for Bankruptcy Protection

Bankruptcy courts wield broad discretion to dismiss Chapter 11 bankruptcy cases for "cause" under Section 1112(b) of the Bankruptcy Code. While the Code lists numerous instances for clear dismissal, courts consider cases filed in "bad faith."

Assessing bad faith varies among courts. While some are skeptical, most find a lack of cash to operate the business consistent with good faith to file for bankruptcy protection. However, the Bankruptcy Code allows filing even when not insolvent.

In Re Aearo Technologies LLC prompted the question: how close to insolvency must a debtor be to act in good faith?

The Aearo court considered previous case law and framed the issue around a debtor's need. They found that a valid reorganization plan designed to preserve or create value for creditors indicated good faith. Aearo's bankruptcy, though financially healthy, aimed to mitigate mass tort litigation liabilities.

Despite facing significant potential liabilities, Aearo's financial health led the court to dismiss the case. While the court left room for refiling in drastic financial changes, they found Aearo's presence in bankruptcy unjustified.

The court's decision underscores that while debtors may utilize bankruptcy protections, doing so needlessly when financially sound exceeds the system's intent. Such cases do not align with Chapter 11's purpose.