Not so fast! How Poor Planning Can Doom Your Chapter 11 Filing Nelson Mullins Riley & Scarborough LLP
Texas bankruptcy court ruling earlier this year to dismiss the National Rifle Association’s (“NRA”) Chapter 11 bankruptcy case as bad faith case illustrates the dangers of a Chapter case. 11 poorly planned and highlights the need, even in crisis situations, to set solid goals and develop a solid strategy before to seek redress under the Bankruptcy Code. In re Nat’l Rifle Ass’n of Am., 628 BR 262 (Bankr. ND Tex. 2021). Notwithstanding the unique facts and circumstances, In re Nat’l Rifle Ass’n of Am. provides sample textbooks of things you should not do when filing a corporate Chapter 11 case.
In its opinion, the North Texas District Bankruptcy Court highlighted recent events in the history of the NRA prior to filing for bankruptcy, including: (1) the New York Attorney General (“NYAG”) opened NRA surveys in 2017; (2) The New York Department of Financial Services urged insurers and financial institutions in April 2018 to assess whether their dealings with the NRA were damaging their company’s reputation and compromising public safety; (3) several whistleblowers informing the NRA audit committee in July 2018 of alleged misconduct on the part of NRA management, including conflicts of interest of senior management and board members. administration and improper reimbursement of living expenses for some employees; and (4) the NYAG filed a lawsuit against the NRA in New York State court on August 6, 2020 to seek the dissolution of the NRA (the “NYAG Action”).
Approximately 3 months after the NYAG action, on November 23, 2020, the NRA retained the services of a counsel to advise them on bankruptcy and restructuring options. The very next day, the entity “Sea Girt, LLC” was formed, as a “transitional vehicle to facilitate the relocation of the NRA to Texas”. Username at 267. At a board meeting on January 7, 2021, the NRA board approved the employment contract of NRA executive vice president Wayne LaPierre, which included a provision authorizing Mr. LaPierre to “exercise corporate authority in furthering the mission and interests of the NRA, including, without limitation, to reorganize or restructure the affairs of the Association for the purposes of minimizing costs, regulatory compliance or otherwise. Identifier. at 267-68. There was no discussion of the bankruptcy or reorganization at the board meeting, and the board was never informed that the employment contract authorized Mr. LaPierre to unilaterally file a bankruptcy petition for the NRA. Days after the board meeting on January 15, 2021, the NRA and Sea Girt, LLC filed voluntary petitions for Chapter 11 relief.
About a month after the bankruptcy case began, several parties, including the NYAG, filed petitions for various remedies that the bankruptcy court classified as generally falling into three categories: (1) dismissal; (2) the appointment of a Chapter 11 Trustee; or (3) the appointment of an examiner. Identifier. at 270. In deciding the petitions, the bankruptcy court adopted the flexible Fifth Circuit view that the term “cause” in Section 1112 (b) (4) could include “a finding that the remedy debtor for compensation is not in good faith ”. Username to 270.
The court’s good faith analysis largely focused on the reasons for the NRA’s bankruptcy filing. After evaluating the relevant arguments and evidence, the Court concluded that the real purpose of filing for bankruptcy was to avoid the dissolution of the NYAG share. The Court noted that although there was “some evidence that the NRA wants[ed] to rationalize litigation and control litigation costs,… ”which did not seem to be“ the real objective ”behind filing for bankruptcy. Identifier. at 278. On the contrary, there was evidence that the NRA could afford to pay its legal fees and no analysis had been made of the comparative cost of litigation outside bankruptcy versus the cost of litigation in the case. of bankruptcy. While the question of “[w]if the NRA’s desire to leave New York and reintegrate in Texas was a real reason to file for bankruptcy [was] a narrower appeal, ”the court was not persuaded that the conditions the NRA faced before the NYAG action posed an existential threat and a reason to file for bankruptcy in order to move to Texas. Identifier. at 278. The CFO’s testimony that “he was not aware of any reason to file for bankruptcy” also did not support the argument that bankruptcy was filed for financial reasons. Identifier. at 279. In the Court’s view, the other reasons the NRA gave for filing for bankruptcy, such as “preserving the NRA as a going concern” could all be grouped under the general reason to avoid dissolution in the NYAG share. Identifier. to 279.
For its subsequent analysis of whether avoiding dissolution in the NYAG action was a valid objective, the Court conducted the two-part investigation used by the Third Circuit, namely: “ (1) whether the petition serves a valid bankruptcy purpose and (2) whether the petition is filed simply to gain a tactical advantage in litigation. ” Identifier. at 280. The Court held that a legal action for a pecuniary judgment, which could be financially ruinous to a debtor, was different from an enforcement action by the state specifically aimed at dissolution under the laws of that judgment. State that must meet certain requirements. The Court ruled that the NRA case was a case of bad faith because its objective was (1) to “deprive the New York GA of the remedy of dissolution, which constitutes a distinct advantage in litigation” and “[to deprive] New York State’s ability to regulate nonprofit corporations in accordance with its laws. ” Identifier. to 281.
In considering whether the appointment of a trustee or examiner was in the best interests of creditors, the Court noted “vile” facts such as evidence of past misconduct by the NRA, including gaps in the records. senior management financial information. Identifier. at 283. The Court was even more concerned about the “clandestine manner in which Mr. LaPierre obtained and exercised the power to file for bankruptcy for the NRA”, where he had excluded key individuals such as the CFO and the General Counsel of decision making. to treat. Identifier. at 284. The determination of whether or not to appoint an administrator or reviewer was further complicated because the mission of the NRA was, “at times, political and polarizing” and because “[t]A NRA does not sell any goods or services ”, it would be difficult to find the appropriate trustee to serve as a trustee or reviewer. Identifier. at 284. Lauding the progress made by the NRA in recent years, resulting in greater disclosure and self-reporting, the Court concluded that, “[o]Outside of bankruptcy, the NRA can pay its creditors, continue to fulfill its mission, continue to improve its governance and internal controls, challenge the dissolution of NYAG Enforcement Action, and continue with the legal steps necessary to leave New York. Identifier. at 284-85.
In re Nat’l Rifle Ass’n of Am. Vividly demonstrates the danger of hastily filing a Chapter 11 dossier and then formulating a narrative post-petition as to the grounds for filing which are not supported by evidence. The inconsistency between the NRA’s arguments in bankruptcy court and the reasons publicly announced by the NRA to justify filing for bankruptcy, including a post on its NRA website which stated: “This action is necessitated primarily by one thing: the deregulation and political attack on the NRA by the New York attorney general. The court also expressed frustration at the lack of clarity caused by conflicting witness testimony on the purpose of the bankruptcy filing. When the CFO testifies that there is no financial reason to file for bankruptcy, how do you claim that bankruptcy was filed to reorganize the debtor? The NRA’s position was also detrimental to corporate governance failures where there had been no voting or even discussion by the board of directors on bankruptcy and restructuring options, and it was clear that the decision to file Chapter 11 was made by one person. This case shows that, given the significant costs associated with a reckless bankruptcy filing which is then rejected, it is essential to establish clear objectives, articulate a coherent strategy and practice good corporate governance. before when filing a Chapter 11 case.