Filing Bankruptcy in Bad Faith will not save your home in New York

Bankruptcy court imposes large fine for acting in bad faith in New York

In re: CANTICO INTERNATIONAL, LTD., Alleged Debtor.
Involuntary Petition Under Chapter 11, Case No. 07-11903 (REG)

Case Law
UNITED STATES BANKRUPTCY COURT FOR THE SOUTHERN DISTRICT OF NEW YORK
2008 Bankr. LEXIS 939

March 19, 2008, Decided

Facts: The debtor defaulted on the mortgage loans that the trustee bank held in an individual retirement account. The putative owner of the property was in possession of but the trustee obtained a judgment of foreclosure. The court imposed a $ 15,470 monetary sanction against the owner and his attorney under the objective test and Fed. R. Bankr. P. 9011 test because their involuntary chapter 11 filing against the debtor was made in bad faith, without reasonable inquiry as to the bases for filing and with intent to delay the foreclosure and extend the owner's possession rent-free without justification.

Issue: Whether the debtor acted in bad faith in filing the petition

Ruling: Yes. The court held that the owner was not a creditor of the debtor at the time the owner filed the involuntary petition and any claim against the debtor was in dispute and could have been decided in state court. The court found no basis to file the petition given that the debtor was a defunct entity, which had no on-going business operations and had bare legal title to the property as its only asset.

Lesson Learned: Courts use four different approaches to determine whether an involuntary petition was filed in bad faith: (a) an "improper use test," which inquires into whether the petitioner is using the bankruptcy system to obtain a disproportionate advantage over other creditors rather than attempting to protect itself against other creditors obtaining a disproportionate advantage; (b) an "improper purpose test," which inquires into whether the petitioner was motivated by such things as ill will, malice, or a desire to embarrass or harass the alleged debtor; (c) an "objective test," which inquires into what a reasonable person would have believed in connection with the purpose of 11 U.S.C.S. § 303 and the allegations required to be made; and (d) a Fed. R. Bankr. P. 9011 test, which inquires into whether the petition (i) was justified based upon a reasonable inquiry into the facts and the law; and (ii) was interposed for an improper purpose.

Written by Kevin Levonas and Jerry L.