Bankruptcy No Sanctuary Against Government Enforcement: NRA Chapter 11 Case Dismissed on Bad Faith | Weil, Gotshal & Manges LLP
[co-author: Alex Xiao]
In May 2021, Judge Harlin D. Hale of the United States Bankruptcy Court for the North District of Texas dismissed the Chapter 11 cases filed by the National Rifle Association. The court found that the organization filed for bankruptcy to gain an unfair litigation advantage and avoid state regulatory action by the New York attorney general, which is not a valid bankruptcy goal. This high-profile case demonstrates that while the bar is not high for an organization to protect itself from creditors under the United States Bankruptcy Code, a barrier to entry remains. In re National Rifle Association of America and Sea Girt, LLC, n ° 21-30085 (Bankr. ND Tex. 11 May 2021).
On August 6, 2020, the New York Attorney General (the “NYAG”) filed an action for execution in New York State court against the National Rifle Association (the “NRA”), alleging that the NRA had violated various provisions of the New York Not-For-Profit Law and calling, among other things, for the dissolution of the NRA. The enforcement action also listed some current and former NRA operatives as individual defendants, including its executive vice president Wayne LaPierre, demanding the return of those individuals’ funds.
On January 15, 2021, the NRA and its newly formed Texan affiliate Sea Girt, LLC, jointly filed voluntary bankruptcy Code Chapter 11 relief petitions in the North District of Texas. As the documents filed by the NRA explain, the Chapter 11 filing was intended to (1) streamline and resolve all outstanding claims and disputes in order to preserve the going concern of the NRA and (2) enable the NRA to come out of bankruptcy as a Texas-based business. non-profit. In addition, the NRA has announced its intention to come up with a plan that would pay off all authorized creditors’ claims in full.
Following the petitions, several interested parties filed motions to dismiss the Chapter 11 cases, alleging bad faith, including the NYAG, the District of Columbia Attorney General and Ackerman McQueen, Inc., one of the vendors. the most important of the NRA. In addition, a long-time member, donor and director of the NRA, Judge Phillip Journey, filed a petition under Section 1104 (c) of the Bankruptcy Code requesting the appointment of an examiner with broad powers to investigate the governance of the NRA and the actions of its leadership.
After weeks of discovery, Justice Hale held a 12-day hearing on the dismissal motions and the motion to appoint an examiner, with 23 witnesses.
He ultimately allowed the motion to dismiss and dismissed the request for the appointment of an examiner.
Bad Faith Filing: Legal Standards
Article 1112 (b) (4) of the Bankruptcy Code provides a non-exhaustive list of “causes” for dismissing a bankruptcy case. Most courts, including the Fifth Circuit Court of Appeals, have held that the lack of good faith in the filing constitutes grounds for dismissal. In re Little Creek Dev. Co., 779 F.2d 1068, 1072-73 (5th Cir. 1986). A case is not filed in good faith unless it has a valid bankruptcy objective. With regard to SGL Carbon Corp., 200 F.3d 154, 165 (3d Cir. 1999). Bankruptcy courts examine whether a case is filed in good faith by considering all of the circumstances, including “debtors’ financial situation, motives and local financial realities.” Small stream, 779 F.2d at 1072. Two inquiries are particularly relevant to the question of good faith: (1) whether the petition serves a valid bankruptcy purpose and (2) whether the petition is filed simply to gain a tactical advantage in the matter. of dispute. In re 15375 Mem’l Corp., 589 F.3d 605, 618 (3d Cir. 2009).
Filing in bad faith: the court’s decision
Relying on three main factors, the court held that the main objective of the NRA was to avoid a potential dissolution of the enforcement action of the NYAG.
First, at the time of the petition, not only was the NRA solvent, it was also in “the strongest financial position in years”. In addition, the court found no evidence to suggest that the NRA filed for bankruptcy to reduce operating costs, to deal with heavy enforceable contracts and unexpired leases, or otherwise to obtain a breathing period, each of which would have been a valid bankruptcy goal. As its CFO testified, the NRA had no financial reason to file for bankruptcy.
Second, the court was not convinced by the NRA’s claim that it filed for bankruptcy to move the home from New York to Texas. The court noted that not only could the NRA transfer the domicile out of bankruptcy, but that alleged goal of filing for bankruptcy also failed to explain the timeline, as testimony during the trial showed that the transfer had been considered by the NRA leadership for some time.
Third, the existing litigation facing the NRA did not pose an imminent financial threat to the financial security of the NRA. Although the NRA has claimed that bankruptcy proceedings will simplify litigation and reduce court costs, it has admitted that the costs of bankruptcy proceedings will also be high. In addition, the NRA had not performed an analysis of the cost of court proceedings outside bankruptcy versus the cost of bankruptcy and court proceedings in bankruptcy, nor did the NRA had difficulty paying legal fees before filing the petition.
These factors led the court to conclude that the NRA’s use of bankruptcy proceedings was for the sole purpose of avoiding the New York State regulatory regime. This was confirmed by Mr LaPierre’s testimony that the NRA did not file for bankruptcy, but for the NYAG lawsuit.
The court then ruled that avoiding a government regulatory scheme was not a valid bankruptcy goal and, therefore, the Chapter 11 filing should be dismissed. Recognizing that the NYAG’s coercive action to dissolve the NRA posed an existential threat to the organization, the court nonetheless ruled that the bankruptcy proceedings are not a “sanctuary” against this type of threat. Justice Hale distinguished between enforcement actions specifically aimed at dissolution and lawsuits that potentially pose a significant financial liability threat. Unlike the latter, which is the classic scenario where dissolution is only a collateral effect of the dispute, the first type of action is not protected by the Bankruptcy Code. The NRA’s bankruptcy filing was therefore not filed in good faith, but rather to gain an unfair advantage against NYAG’s enforcement actions and to avoid a regulatory regime, constituting cause for dismissal.
Request for appointment of examiner or trustee refused
Following its analysis of Article 1112 (b) (1) of the Bankruptcy Code relating to dismissal, the court also considered whether to appoint an examiner or a trustee, but concluded that this was not in the best possible way. interest of creditors and the estate. The court observed that “the NRA does not sell goods or services, and it would not be easy to find a suitable person to play the role of trustee or reviewer with extended powers.” Additionally, given the political importance of the NRA, the appointment of a reviewer or administrator may deter some members or donors from continuing to support the organization.
However, Justice Hale expressed his concerns about the corporate governance issues revealed before and during the bankruptcy case, including the lack of transparency. For example, the court was particularly concerned that the decision to file for bankruptcy had been made largely by Mr. LaPierre alone, with limited consultation with certain board members and without informing the majority of the board. or officers such as the chief financial officer and general counsel. Therefore, although the court dismissed the case without prejudice, the opinion noted that if the NRA filed for bankruptcy again, the court “would immediately address some of its concerns about disclosure, transparency, secrecy, conflicts of interest. . . which could result in the appointment of a trustee for fear that the NRA could not fulfill the fiduciary duty required by the Bankruptcy Code for a debtor in possession.
Take away food
Although the good faith requirement in bankruptcy filings is a case-by-case investigation, it is important that the court distinguish between government enforcement actions aimed at dissolving the organization from disputes that present the risk of threatening liabilities. the existence of an organization. Citing the former as a reason for filing for bankruptcy may be considered inappropriate, in the absence of other valid bankruptcy purposes, as evidenced by the dismissal of the NRA Chapter 11 case. By the way, this case also underscores the importance of good corporate governance in the lead-up to the filing of the Chapter 11 case. Although the court did not address this issue here, a bankruptcy case can. be rejected if it has not been filed using appropriate corporate governance.