In Re: Integrated

• Court: Court of Appeals for the Third Circuit
• Decided: September 20, 2004
• Docket: 04-2411
• Status: Published

Opinion

Opinions of the United 2004 Decisions States Court of Appeals for the Third Circuit

9-20-2004

In Re: Integrated Precedential or Non-Precedential: Precedential

Docket No. 04-2411

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Recommended Citation "In Re: Integrated " (2004). 2004 Decisions. Paper 273. http://digitalcommons.law.villanova.edu/thirdcircuit_2004/273

This decision is brought to you for free and open access by the Opinions of the United States Court of Appeals for the Third Circuit at Villanova University School of Law Digital Repository. It has been accepted for inclusion in 2004 Decisions by an authorized administrator of Villanova University School of Law Digital Repository. For more information, please contact Benjamin.Carlson@law.villanova.edu. PRECEDENTIAL Before: SMITH, BECKER, and UNITED STATES COURT GREENBERG, Circuit Judges OF APPEALS FOR THE THIRD CIRCUIT (Filed: September 20, 2004)

_________ Seth P. Waxman (Argued) Craig Goldblatt Case No: 04-2411 Wilmer Cutler Pickering __________ Hale & Dorr LLP 2445 M Street, NW IN RE: INTEGRATED TELECOM Washington, DC 20037 EXPRESS, INC. a/k/a INTEGRATED TECHNOLOGY Christopher J. Meade EXPRESS, INC. Wilmer Cutler Pickering a/k/a DELAWARE INTEGRATED Hale & Dorr LLP TELECOM EXPRESS, INC., 399 Park Ave 30th Floor Debtor New York, NY 10022

NM SBPCSLDHB, L.P., Counsel for Appellant

Appellant Laura D. Jones David W. Carickhoff, Jr. v. Pachulski, Stang, Ziehl, Young, Jones & Weintraub P.C. INTEGRATED TELECOM EXPRESS, 919 North Market Street INC.; P.O. Box 8705, 16th Floor and THE OFFICIAL COMMITTEE OF Wilmington, DE 19801 EQUITY HOLDERS, et al. Tobias S. Keller (Argued) On Appeal From The United States Pachulski, Stang, Ziehl, Young, District Court Jones & Weintraub P.C. For The District Of Delaware Three Embarcadero Center (Civ. A. No. 03-236-KAJ) Suite 1020 San Francisco, CA 94111 District Judge: The Honorable Kent A. Jordan Counsel for Appellee Integrated Telecom __________ Express, Inc.

Argued August 3, 2004 Kevin Gross __________ Rosenthal, Monhait, Gross & Goddess 919 North Market Street, Suite 1401 Bankruptcy Code. A p p e l l a nt P.O. Box 1070 NMSBPCSLDHB, L.P. (the “Landlord”) Wilmington, DE 19899 appeals from an order of the District Court affirming the Bankruptcy Court’s denial of Ali M. Mojdehi (Argued) its motion to dismiss for lack of good faith. Baker & McKenzie The Landlord contends that the Debtor, 101 West Broadway Integrated Telecom Express, Inc. 12th Floor (“Integrated”), was never in financial San Diego, CA 92101 distress and that the petition in this case was instead filed to frustrate the Landlord’s Counsel for Appellee Official Committee claims and to increase the distribution of of Equity Security Holders the Debtor’s estate to Integrated’s shareholders at the Landlord’s expense. Robert K. Rasmussen These contentions are corroborated by the Vanderbilt Law School record. First, according to schedules filed 131 21st Ave. South with the Bankruptcy Court, Integrated had Nashville, TN 37240 $105.4 million in cash and $1.5 million in other assets at the time that it filed for G. Marcus Cole bankruptcy, and yet the Landlord’s proof of Stanford Law School claim lists the present discounted value of 559 Nathan Abbott Way Integrated’s le as e o b l ig a t i o ns at Stanford, CA 94305-8610 approximately $26 million. Integrated’s schedules also list miscellaneous liabilities David A. Skeel, Jr. of approximately $430,000. Thus University of Pennsylvania Law School Integrated was highly solvent and cash rich 3400 Chestnut Street at the time of the bankruptcy filing. Even Philadelphia, PA 19104 if the IPO class action claim, which was capped at $25 million with Integrated’s Amicus Curiae in Support of Appellant liability limited to a $5 million reserve (the balance to be paid by insurance) was listed ____________ at its full alleged value, Integrated was still solvent at the time of filing. Second, in a OPINION smoking gun resolution approved by the ___________ Board, and notwithstanding its strong financial position, Integrated authorized a letter to the Landlord threatening that if it SMITH, Circuit Judge. did not enter into a settlement of the lease This appeal tests the limits of the in the amount of at least $8 million, good faith requirement applicable to Integrated would file for bankruptcy so as petitions filed under Chapter 11 of the to take advantage of § 502(b)(6), which

2 sharply limits the amount that a landlord million. Integrated hired a management can recover in bankruptcy for damages and technology consulting firm in resulting from the termination of a lease. December 2001 to help evaluate Integrated’s operating alternatives. The issue on appeal is whether, on Integrated also retained Lehman Brothers, the facts of this case, a Chapter 11 petition an investment bank, in February 2002, to filed by a financially healthy debtor, with assist in identifying, soliciting, and no intention of reorganizing or liquidating evaluating proposals for a sale or merger of as a going concern, with no reasonable Integrated or its assets. Unable to find a expectation that Chapter 11 proceedings third party willing to enter into such a will maximize the value of the debtor’s transaction, and unable to identify an estate for creditors, and solely to take alternative business model, Integrated’s advantage of a provision in the Bankruptcy Board of Directors prepared a plan for the Code that limits claims on long-term liquidation and dissolution of the company leases, complies with the requirements of under state law. the Bankruptcy Code. We conclude that such a petition is not filed in good faith and In November 2001, a securities class will therefore reverse. action styled Richmon v. Integrated Telecom Express, Inc., No. 01-CV-10108- I. SAS, was filed in the Southern District of Integrated was a supplier of New York naming Integrated as a software and equipment to the broadband defendant, along with certain officers, communications industry. In the summer directors, and underwriters of Integrated. of 2000, Integrated negotiated a lease of The class consists of individuals who real property in Silicon Valley with the purchased Integrated stock between August Landlord. After several months of 18, 2000, and December 6, 2000. The negotiation, during which the Landlord class action alleges claims in the amount of evaluated Integrated’s business condition $93.24 million for various violations of the and reviewed the company’s prospectus, Securities Act of 1933 and the Securities Integrated and the Landlord executed a Exchange Act of 1934 in connection with lease for a term of ten years beginning on Integrated’s initial public offering of February 23, 2001, with a monthly base securities. Similar lawsuits concerning rent of $200,000, increasing 5 percent more than 300 other companies’ initial annually. The Landlord was aware of the public offerings have been filed and financial risks associated with Integrated’s coordinated as In re Initial Public Offering business and willingly accepted those risks. Securities Litigation, No. 21-MC-00092- SAS (S.D.N.Y.). 2001 was a very poor year for Integrated. The market for many of the On April 18, 2002, Integrated’s company’s products deteriorated, causing Board approved a Plan of Complete Integrated to suffer net losses of $36.2 Liquidation and Dissolution under

3 Delaware law. The two major issues to be reviewed with the Board the resolved prior to dissolution were (1) the draft letter to the landlord (a disposition of Integrated’s intellectual copy of w hich w as property rights and (2) its remaining previously distributed to the obligations under the lease. In May of Board). 2002, the Board approved the sale of Ms. Murray then reviewed substantially all of Integrated’s intellectual with the Board the timeline . property and related assets to Real Com, a . . for a bankruptcy filing and corporation to be formed by certain of related bankruptcy Integrated’s officers and directors. The procedures. proposed purchase price was $1.5 million plus assumption of Integrated’s technical Various members of the support and warranty obligations. Board then asked questions of Ms. Murray related to the Thereafter, Integrated attempted to draft letter to the landlord negotiate an accord and satisfaction of its and the procedures for, and lease. Integrated asserts that, “[d]uring this implications of, a possible time, Debtor first became aware that it bankruptcy filing by the might use Chapter 11 to, among other Company. A discussion things, address Landlord’s claims.” among the Board ensued, Appellee’s Br. at 6-7. On August 13, including a discussion of the 2002, the Board authorized a Chapter 11 costs and potential benefits filing in the event that the Landlord would and risks of proceeding with not accept $8 million as an accord and a bankruptcy filing. satisfaction of Integrated’s obligations under the lease. The minutes of the August Following that discussion, 13 Board meeting state, in pertinent part: Mr. Regel asked the Board for authority for Mr. Regel [Integrated’s management to negotiate a CEO] updated the Board on settlement with the landlord his discussions with the in an amount in the range of landlord subsequent to the $6 to $7 million. A further last board meeting. Mr. discussion among the Board Regel noted that the landlord ensued regarding the costs did not appear to believe that associated with a bankruptcy t h e C o m p a ny would filing and potential costs of seriously consider making a any litigation. A fter bankruptcy filing. additional discussion, the Ms. Murray [of the law firm Board approved the Murray & Murray] next following resolutions:

4 RESOLVED: That the RESOLVED FURTHER: officers of the Company are, That the officers of the and each of them hereby is, Company be, and each of authorized and directed to them hereby is, authorized send the landlord the letter and directed to instruct prepared by Murray and bankruptcy counsel to begin Murray in substantially the to prepare the necessary form reviewed with the paperwork for a bankruptcy Board. filing. RESOLVED FURTHER: RESOLVED FURTHER: That the officers of the That if the landlord is not Company are, and each of willing to enter into a them hereby is, authorized settlement agreement with a and directed to negotiate a maximum amount of $8 settlement with the landlord million, then the officers of up to a maximum settlement the Company shall be, and amount of $7 million. each of them hereby is, authorized and empowered RESOLVED FURTHER: on behalf of, and in the That the Board hereby name of, the Company to appoints . . . a special execute and verify or certify c o m m it t e e ( t h e a petition under Chapter 11 “Committee”) that is hereby of the Bankruptcy Code and empowered on behalf of the to cause the same to be filed Board to authorize the in the appropriate United officers of the Company to States Bankruptcy Court enter into a settlement with (the “Bankruptcy Court”) at the landlord up to a such time as said authorized maximum settlement amount officer executing the same of $8 million. shall determine. RESOLVED FURTHER: On August 15, 2002, Integrated’s That the officers of the bankruptcy counsel sent the Landlord a Company shall be required letter stating that, if the Landlord was to seek approval from the unwilling to settle, the Debtor was Board prior to entering into prepared to avail itself of various an [sic] settlement with the provisions in the Bankruptcy Code, landlord in excess of $8 including the cap on landlords’ claims set million.

5 forth in 11 U.S.C. § 502(b)(6). 1 The letter asserted that “even if [Integrated] were to file bankruptcy solely to cap the Lessor’s claim using Bankruptcy Code § 1 502(b)(6), a use for which this Code 11 U.S.C. § 502(b)(6) limits the section is intended, [Integrated] would not amount that a landlord can recover in violate the good faith filing doctrine.” bankruptcy for damages resulting from the termination of a lease. Under § No settlement was reached. 502(b)(6), a landlord can recover rent that Proceedings in the Bankruptcy has accrued as of the filing of the Court petition, but may not recover rent remaining on the lease beyond one year’s Integrated filed a voluntary petition rent or 15 percent of the remaining rent for relief under Chapter 11 of the (not to exceed three years), whichever is Bankruptcy Code on October 8, 2002. greater: According to schedules filed with the Bankruptcy Court, Integrated had $105.4 (a) A claim or interest, proof of which is million in cash and $1.5 million in other filed under section 501 of this title, is assets at the time that it filed for deemed allowed, unless a party in interest bankruptcy. The Landlord filed a proof of . . . objects. claim listing the present discounted value of Integrated’s lease obligations at (b) . . . if such objection to a claim is approximately $26 million. Integrated’s made, the court, after notice and a schedules also list miscellaneous liabilities hearing, shall determine the amount of of approximately $430,000. such claim in lawful currency of the Immediately after Integrated filed United States as of the date of the filing its petition, Integrated attempted to address of the petition, and shall allow such claim in such amount, except to the extent that— lease, following the earlier of— ... (i) the date of the filing of the petition; (6) if such claim is the claim of a lessor and for damages resulting from the termination of a lease of real property, (ii) the date on which such lessor such claim exceeds— repossessed, or the lessee surrendered, the leased property; plus (A) the rent reserved by such lease, without acceleration, for the greater of (B) any unpaid rent due under such lease, one year, or 15 percent, not to exceed without acceleration, on the earlier of three years, of the remaining term of such such dates . . . .

6 the two major obstacles to dissolution: the did not expand on this statement except to sale of its intellectual property assets and stress that Integrated “was losing a lot of its remaining obligations under the lease. money.” The court characterized the On October 9, 2002, the day after company’s financial losses as “dramatic.” Integrated filed its petition, Integrated According to the court, Integrated “was moved to sell its intellectual property assets experiencing a dramatic downward spiral” at a public auction. The Official in September 2001. As such, the court Committee of Equity Security Holders (the concluded that “the Board had an “OCESH”) objected to the adequacy of obligation, and appropriately exercised Integrated’s efforts to market the assets. that obligation, to give the investors their Ultimately, Integrated was able to money back.” renegotiate the sale and to introduce other Alternatively, the Bankruptcy Court bidders. As a result, a new agreement was held that, “even assuming” that reached with Real Com for some, but not Integrated’s stated reasons for filing the all, of the assets for $2 million, an increase petition were not “particularly persuasive,” of $500,000. The remaining assets were Integrated’s desire to take advantage of the sold for $500,000 after confirmation of the § 502(b)(6) cap on landlords’ claims was plan of reorganization. not a sufficient basis on which to dismiss Also on October 9, 2002, Integrated the petition “as a matter of law”: moved to reject the lease. The Landlord But even assuming that opposed the motion and, on October 28, those other factors are not 2002, filed a motion to dismiss the Chapter particularly persuasive, even 11 proceeding on the ground that the assuming or accepting the petition was not filed in good faith. On l a n d l o rd’s p o si t io n , January 8, 2003, the Bankruptcy Court particularly illustrated by the conducted an evidentiary hearing on the Board of Directors’ minutes motion to dismiss and the motion to reject of August 13 of ‘02, that the the lease during which it heard evidence principal reason for the regarding Integrated’s decision to file for Chapter 11 case was to cap Chapter 11. After the close of evidence, the damage claim for the the Bankruptcy Court determined that oral landlord, I conclude that as argument was unnecessary and denied the a matter of law, that is not a motion to dismiss from the bench. debilitating fact. I held in The Bankruptcy Court explained at [In re PPI Enterprises the hearing that Integrated “offered a (U.S.), Inc., 228 B.R. 339 number of reasons for the filing of the (Bankr. D. Del. 1998), aff’d, bankruptcy case,” and that the court 324 F.3d 197 (3d Cir. “believe[d] there is validity to a number of 2003)], and other cases have those considerations.” The court, however, held, that it does not

7 establish bad faith for a was not leveraged. And debtor to file a chapter 11 instead of the significant case for the purpose of distribution going to debt taking advantage of holders . . . it’s going to go prov isions wh ich alte r to the shareholders. pre-petition rights, including The Bankruptcy Court then went on to altering the rights of a discuss “other decisions that agree with landlord under State law. that proposition, namely that a solvent The Bankruptcy Court was guided debtor can avail itself of the 502(b)(6) by the following proposition: “[A]s the cap,” focusing in particular on In re case law clearly indicates, not limited to Sylmar Plaza, L.P., 314 F.3d 1070 (9th my case [referring to the Bankruptcy Cir. 2002), and characterizing Sylmar as Judge’s decision in PPI], the solvency of “almost on all fours with the situation the debtor and the fact that the equity before me.” interest holders will receive a distribution With respect to the equities of the does not serve as the basis for a finding of case, the Bankruptcy Court found that, bad faith.” The court thus saw no although the shareholders would realize a significance in the fact that the § 502(b)(6) “benefit” from the bankruptcy in the form cap would operate solely to the benefit of of a “significant distribution,” “the equity holders, as opposed to creditors: shareholders are not coming out whole by What I think is also any means.” The court concluded that significant in this case is that “obviously you can’t consider that they . . . this debtor had no [i.e., the shareholders] are being treated significant debt. . . . [to] any windfall.” Conversely, the court found that the Landlord elected to “ride The difference in this with the bulls,” when it entered into the case is that the company was lease with Integrated, and that, as a not at all leveraged. And if “sophisticated individual” who “took the the distribution were, for the risk [hoping] that his instincts were right,” most part, or totally to go to he must “suffer the consequences” of his the creditors, there would be instincts being wrong. On January 30, no basis for the landlord to 2003, the Bankruptcy Court issued an complain regarding some order formally denying the motion “for the equitable principle. reasons stated on the record at the But I don’t think the Hearing.” Code makes any distinction. The B ankruptcy Court Confirm s And I think that the—why Integrated’s Plan of Liquidation this case is different is because the debtor simply The Bankruptcy Court held a

8 confirmation hearing on April 7, 2003, and that regard, it’s also worth issued an order confirming Integrated’s noting that [this] Chapter 11 proposed plan of liquidation over the case had the effect on the Landlord’s objections on April 16, 2003. securities law plaintiffs Applying § 502(b)(6), the Landlord’s claim similar to its effect on this was reduced from $26 million to $4.3 landlord. It effectively million. reduced the recovery by the securities law claimants by The plan of liquidation did not t r e a ti n g th e m lik e completely resolve the securities class shareholders pursuant to action. Instead, the plan reserved $5 Section 510(b).[ 2 ] million of the debtor’s estate to satisfy any judgment that might be entered in the Could the securities securities class action. When added to $20 law plaintiffs obtain a bad million in insurance coverage available to faith ruling in this case? I Integrated, the plan effectively limited any don’t think so for essentially potential judgment in the securities class the same reasons I think that action to $25 million. The securities class the landlord cannot. voted in favor of the plan of liquidation. With respect to the The Landlord appealed to the securities law action, I am District Court and moved the Bankruptcy puzzled to understand how Court to stay confirmation of the plan that claim could be resolved pending appeal. The Bankruptcy Court in a non-bankruptcy law addressed the Landlord’s motion for a stay liquidation context absent a at an April 29, 2003 hearing. The final resolution of that Bankruptcy Court reaffirmed its earlier claim. In a non-bankruptcy ruling on the Landlord’s motion to dismiss, law context, the securities making several “observations to amplify law plaintiffs would have the record on the issue.” Specifically, the Bankruptcy Court elaborated on the significance of the securities class action: 2 11 U.S.C. § 510(b) subordinates claims for damages arising from the There is nothing in the law purchase or sale of a security of the to sugg est that the debtor to all claims and interests that are corporation cannot avail senior or equal to the claim or interest itself to the distribution represented by such security. Where, as scheme set forth in the here, the security is common stock, the Bankruptcy C ode in claim has the same priority as common effecting that liquidation. In stock. Collier on Bankruptcy §§ 510.01, 510.04[1] (15th ed. 2004).

9 h a d a v e r y s t r at e g ic THE COURT: Well, advantage, namely so long as I—they could. But I believe there w as a po ssible they would be in breach of recovery again st the their fiduciary duty if they corporation, the liquidation did, and I made this would be stalled indefinitely. observation back in January. The Bankruptcy Court nevertheless stayed The Bankruptcy Court also its confirmation order pending appeal, on commented on Integrated’s financial the condition that the Landlord post a $2.5 affairs leading up to its decision to file for million bond. Chapter 11: Appeal to the District Court THE COURT: Are you The District Court affirmed, sa yi ng that Integrate d holding that the Bankruptcy Court did not Tele com is a healthy abuse its discretion in denying the company? Landlord’s motion to dismiss. The District MR. HAZELTINE: Your Court concluded that the Bankruptcy Court Honor, Integrated Telecom made two specific findings of fact: (1) that as it sits here today is a very in September 2001 the Debtor was in healthy company. At the “financial distress”; and (2) that the Board, t im e i t e n t e r e d f o r consistent with its fiduciary responsibility, bankruptcy it was a very properly pursued liquidation in order to healthy company. They fulfill its obligations to its investors. The had— District Court did not disturb either finding. THE COURT: They’re out of business, aren’t they? The District Court understood the Bankruptcy Court to have alternatively MR. HAZELTINE: They’re ruled, as a matter of law, that “even if the out of business. But their Debtor’s principal reason for filing its balance sheet looks great. Chapter 11 case was to cap the Landlord’s They have $105 million in damage claim, that alone was insufficient assets, $28 million in debts if to establish bad faith.” The District Court the landlord’s claim is not concluded that the Bankruptcy Court’s capped. legal ruling “was based on a sound They could become interpretation of relevant case law from an investment company, this and other jurisdictions, and does not invest that money and constitute an abuse of discretion.” The make—make money. They District Court rejected the Landlord’s just— argument that “permitting a solvent

10 corporation to invoke the landlord cap 1112(b) unless filed in good faith, and the would permit an end run around a core burden is on the bankruptcy petitioner to principle of bankruptcy law, the ‘absolute establish that its petition has been filed in priority rule’—that is, that creditors must good faith. In re SGL Carbon Corp., 200 be paid in full before stockholders can F.3d 154, 159-62 (3d Cir. 1999); accord retain equity interests for any purpose.” Solow v. PPI Enters. (U.S.), Inc. (In re PPI Like the Bankruptcy Court, the District Enters. (U.S.), Inc.), 324 F.3d 197, 211 (3d Court observed that insolvency is not a Cir. 2001) (“The debtor bears the burden prerequisite to filing under Chapter 11. of establishing good faith.”). 3 Whether the Regardless, in light of the Bankruptcy good faith requirement has been satisfied Court’s finding that Integrated was is a “fact intensive inquiry” in which the “experiencing a dramatic downward spiral” court must examine “the totality of facts and that filing a Chapter 11 petition and circumstances” and determine where fulfilled the Board’s obligations to a “petition falls along the spectrum shareholders, the District Court concluded ranging from the clearly acceptable to the that no such “end run” had taken place. patently abusive.” Id. at 162. We Although the District Court affirmed the therefore review for abuse of discretion the Bankruptcy Court’s ruling, the District Bankruptcy Court’s refusal to dismiss a Court extended the Bankruptcy Court’s Chapter 11 petition for want of good faith. stay of the confirmation order. Solow v. PPI Enters. (U.S.), Inc. (In re PPI Enters. (U.S.), Inc.), 324 F.3d 197, 211 (3d The Landlord filed a timely appeal Cir. 2003). “[A]n abuse of discretion from the District Court’s order. We exists where the district court’s decision expedited the appeal and stayed the Bankruptcy Court’s confirmation order pending the appeal. Jurisdiction in the 3 District Court was proper under 28 U.S.C. Under 11 U.S.C. § 1112(b), “the § 158(a), and we exercise jurisdiction court may convert a case under [Chapter under 28 U.S.C. § 158(d). Although this 11] to a case under Chapter 7 . . . or may Court’s jurisdiction is over the decision of dismiss a case under this chapter, the District Court, 28 U.S.C. § 158(d), whichever is in the best interest of “review of the District Court’s decision creditors and the estate, for cause.” The effectively amounts to review of the statute lists 10 non-exhaustive factors bankruptcy court’s opinion in the first that may amount to cause. H.R. Rep. No. instance.” In re Hechinger Inv. Co. of 95-595, at 406 (1977), reprinted in 1978 Del., 298 F.3d 219, 224 (3d Cir. 2002). U.S.S.C.A.N. 5963, 6362 (“[The] list [contained in § 1112(b) ] is not II. exhaustive. The court will be able to Chapter 11 bankruptcy petitions are consider other factors as they arise, and subject to dismissal under 11 U.S.C. § to use its equitable powers to reach an appropriate result in individual cases.”).

11 rests upon a clearly erroneous finding of Court has identified two of the basic fact, an errant conclusion of law, or an purposes of Chapter 11 as (1) “preserving improper application of law to fact.” SGL going concerns” and (2) “maximizing Carbon, 200 F.3d at 159 (quoting ACLU v. property available to satisfy creditors.” Black Horse Pike Reg’l Bd. of Ed., 84 F.3d Bank of Am. Nat’l Trust & Sav. Ass’n v. 1471, 1476 (3d Cir. 1996)). 203 N. LaSalle St. P’ship, 526 U.S. 434, 453 (1999); accord Toibb v. Radloff, 501 At its most fundamental level, the U.S. 157, 163-64 (1991) (discussing “the good faith requirement ensures that the congressional purpose of deriving as much Bankruptcy Code’s careful balancing of value as possible from the debtor’s interests is not undermined by petitioners estate”). Each of these purposes informs whose aims are antithetical to the basic our application of the good faith purposes of bankruptcy: requirement: “[A good faith standard] “Review and analysis of furthers the balan cin g [the bankruptcy laws and process between the interests relevant cases] disclose a of debtors and creditors common theme and which characterizes so many objective [underlying the provisions of the bankruptcy reorganization provisions]: laws and is necessary to avoidance of the legitimize the delay and consequences of economic costs imposed upon parties d is m em b e rm e n t a n d to a bankruptcy. l i q u i d a t io n , a n d t h e Requirement [sic] of good preservation of ongoing faith prevents abuse of the values in a manner which bank ruptc y process by does equity and is fair to debtors whose overriding rights and interests of the motive is to delay creditors parties affected. But the without benefitting them in perimeters of this potential any way . . . .” mark the borderline between SGL Carbon, 200 F.3d at 161-62 (quoting fulfillment and perversion; Little Creek Dev. Co. v. Commonwealth between accomplishing the Mortgage Corp. (In re Little Creek Dev. objectives of rehabilitation Co.), 779 F.2d 1068, 1072 (5th Cir. 1986)); and reorganization, and the see also Carolin Corp. v. Miller, 886 F.2d use of these statutory 693, 698 (4th Cir. 1989) (good faith provisions to destroy and requirement is “indispensable to proper undermine the legitimate accomplishment of the basic purposes of rights and interests of those Chapter 11 protection”). The Supreme intended to benefit by this

12 sta t utory p o licy. T hat going concern or maximizing the value of borderline is patrolled by the debtor’s estate, and (2) whether the courts of equity, armed with petition is filed merely to obtain a tactical the doctrine of ‘good faith’ . litigation advantage. SGL Carbon, 200 . . .” F.3d at 165. SGL Carbon, 200 F.3d at 161 (quoting In It is easy to see why courts re Victory Constr. Co., Inc., 9 B.R. 549, have required Chapter 11 558 (Bankr. C.D. Cal. 1981), order stayed petitioners to act within the Hadley v. Victory Constr. Co., Inc. (In re scope of the bankruptcy Victory Constr. Co., Inc.), 9 B.R. 570 laws to further a valid (Bankr. C.D. Cal. 1981)); see also Marsch reorganizational purpose. v. Marsch (In re Marsch), 36 F.3d 825, 828 Chapter 11 vests petitioners (9th Cir. 1994) (“The test is whether a with considerable debtor is attempting to unreasonably deter powers—the automatic stay, or harass creditors or attempting to effect a the exclusive right to speedy, efficient reorganization on a propose a reorganization feasible basis.”); United Sav. Ass’n of Tex. plan, the discharge of debts, v. Timbers of Inwood Forest Assocs., Ltd. etc.— that can impose (In re Timbers of Inwood Forest Assocs., significant hardship on Ltd.), 808 F.2d 363, 373 (5th Cir. 1987) (en particular creditors. When banc) (stating that if Chapter 11 plan does financially troub led not have a rehabilitative purpose, the petitioners seek a chance to “statutory provisio ns designed to remain in business, the accomplish the reorganization objective exercise of those powers is become destructive of the legitimate rights justified. But this is not so and interests of creditors, the intended when a petitioner’s aims lie beneficiaries”); Connell v. Coastal Cable outside those of th e T.V., Inc. (In re Coastal Cable T.V., Inc.), Bankruptcy Code. 709 F.2d 762, 764 (1st Cir. 1991) (Breyer, J.) (stating that there must be “some r e l a ti o n — a t l e a s t a n a r g u a b l e Id. at 165-66.4 Likewise, “because filing a relation—between the chapter 11 plan and the reorganization-related purposes that the 4 chapter was designed to serve”). In SGL Carbon, we used the phrase “a valid reorganizational purpose” Our cases have accordingly focused because that case involved a plan of on two inquiries that are particularly reorganization. See SGL Carbon, 200 relevant to the question of good faith: (1) F.3d at 167. Reorganization, however, is whether the petition serves a valid not the only “appropriate use of Chapter bankruptcy purpose, e.g., by preserving a 11 since the Code clearly contemplates

13 Chapter 11 petition merely to obtain tactical litigation advantages is not within ‘the legitimate scope of the bankruptcy laws,’ courts have typically dismissed liquidating plans under 11 U.S.C. § Chapter 11 petitions under these 1123(b)(4), whereby a debtor may circumstances as well.” Id. at 165 develop a Chapter 11 plan to sell off all (quoting In re Marsch, 36 F.3d at 828); see of its assets.” PPI, 324 F.3d at 211; also Furness v. Lilienfield, 35 B.R. 1006, accord 11 U.S.C. § 1123(b)(4) (“[A] plan 1013 (D. Md. 1983) (“The Bankruptcy may . . . provide for the sale of all or provisions are intended to benefit those in substantially all of the property of the genuine financial distress. They are not estate, and the distribution of the intended to be used as a mechanism to proceeds of such sale among holders of orchestrate pending litigation.”). claims or interests . . . .”). Yet liquidation plans, no less than reorganization plans, A. must serve a valid bankruptcy purpose. A s the Ban krup tcy C ourt That is, they must either preserve some recognized, Integrated is unquestionably going concern value, e.g., by liquidating a “out of business,” and therefore has no company as a whole or in such a way as going concern value to preserve in Chapter to preserve some of the company’s 11 through reorganization or liquidation goodwill, or by maximizing the value of under the Bankruptcy Code. The question the debtor’s estate. therefore becomes whether Integrated’s p e t i ti o n m i g h t r e as o n a b l y h a v e We therefore reject the OCESH’s “maximiz[ed] the value of the bankruptcy argument that the good faith inquiry estate.” Toibb, 501 U.S. at 163; accord applies with less force to liquidation 203 N. LaSalle, 526 U.S. at 453. For the plans because, since ownership is not reasons that follow, we conclude that it allowed to retain an interest in the would not. reorganized entity, the potential for bad faith is reduced. The good faith To say that liquidation under requirement is necessitated as much by Chapter 11 maximizes the value of an the hardship of Chapter 11 to certain entity is to say that there is some value that interests as it is by the benefit to others. otherwise would be lost outside of SGL Carbon, 200 F.3d at 161-62, 165-66. ba nk ru pt cy. E l i z a b e th W a r r e n , Moreover, the facts of this case Bankruptcy Policymaking In an Imperfect demonstrate the fallacy of the OCESH’s World, 92 Mich. L. Rev. 336, 350 (1993) argument. While the owners of (“Two empirically based economic Integrated may never recover the full assumptions underlie the attempt to value of their investments, they stand to preserve the value of a failing company: reap a substantial gain through (1) orderly liquidation is likely to produce bankruptcy, at the expense of the more value— or to avoid more loss—than company’s sole creditor.

14 piecemeal liquidation; and (2) going- Inc., 871 F.2d 1023, 1027 (11th Cir. 1989) concern value is likely to be higher than (recognizing that one factor relevant to liquidation value.”); Collier on Bankruptcy good faith is “whether the debtor is ¶ 1108.12 (“[W]here liquidation is ‘financially distressed’” and affirming appropriate, the Code contemplates orderly dismissal of petition for, inter alia, use of liquidation and not a ‘fire sale.’”). At its bankruptcy proceedings despite the most basic level, the Bankruptcy Code apparent good financial health of the maximizes value by alleviating the problem debtor”); Little Creek, 779 F.2d at 1072 of financial distress. See Thomas H. (“Determining whether the debtor’s filing Jackson, The Logic and Limits of for relief is in good faith depends largely Bankruptcy Law 10 (1986) (“The basic upon the bankruptcy court’s on-the-spot problem that bankruptcy law is designed to evaluation of the debtor’s financial handle, both as a normative matter and as condition, motives, and the local financial a positive matter, is that the system of realities.”); In re The Bible Speaks, 65 individual creditor remedies may be bad B.R. 415, 424-26 (Bankr. D. Mass. 1986) for the creditors as a group when there are (concluding that, despite the absence of a not enough assets to go around.”). As statutory financial eligibility standard in Integrated conceded at oral argument, good Chapter 11, “[t]he legislative history [to faith necessarily requires some degree of the Bankruptcy Code] indicates that financial distress on the part of a debtor. Congress intended Chapter 11 to be See SGL Carbon, 200 F.3d at 166 (“Courts, resorted to by business entities which are therefore, have consistently dismissed experiencing some type of financial Chapter 11 petitions filed by financially difficulty”); In re Talladega Steaks, Inc., healthy companies with no need to 50 B.R. 42, 44 (Bankr. N.D. Ala. 1985) reorganize under the protection of Chapter (dismissing petition w here d ebtor 11.” (emphasis added)); Coastal Cable, “presented no evidence that financial 709 F.2d at 765 (“To meet the ‘good faith’ difficulties had precipitated the filing of requirement . . . many courts have held that the petition and indeed testified that the a reorganization plan must bear some debtor’s debts and other financial relation to the statutory objective of obligations were substantially current”). resuscitating a financially troubled To be sure, a debtor need not be corporation.” (emphasis added)); Baker v. insolvent before filing for bankruptcy Latham Sparrowbrush Assocs. (In re protection. SGL Carbon, 200 F.3d at 163- Cohoes Indus. Terminal, Inc.), 931 F.2d 64. 222, 228 (2d Cir. 1991) (“Although a debtor need not be in extremis in order to [T]he drafters of the file such a petition, it must, at least, face Bankruptcy Code such financial difficulty that, if it did not understood the need for file at that time, it could anticipate the need early access to bankruptcy to file in the future.”); In re Dixie Broad., relief to allow a debtor to

15 rehabilitate its business reorganize under t he before it is faced with a protection of Chapter 11. hopeless situation. Such Those courts have encouragement, however, r e c ogni z e d that if a does not open the door to petitioner has no need to premature filing, nor does it rehabilitate or reorganize, its allow for the filing of a petition cannot serve the bankruptcy petition that rehabilitative purpose for l a c k s a v a l i d which Chapter 11 was reorganizational purpose. designed. SGL Carbon, 200 F.3d at 163 (footnote SGL Carbon, 200 F.3d at 166 (citations om itted); see also, e.g., In re omitted). Accordingly, the absence of a Johns-Manville Corp., 36 B.R. 727, 736 solvency requirement recognizes that even (Bankr. S.D.N.Y. 1984) (“Accordingly, the solvent firms can, at times, suffer from drafters of the Code envisioned that a financial distress. Id. at 163 (early access financially beleaguered debtor with real for solvent debtors designed to preempt “a debt and real creditors should not be hopeless situation”); In re M arshall, 300 required to wait until the economic B.R. 507, 512-13 (Bankr. C.D. Cal. 2003) situation is beyond repair in order to file a (“It is not uncommon for debtors to be reorganization petition.”). Saying that solvent under the balance sheet test, and there is no insolvency requirement, yet to have severe financial problems. . . . however, does not mean that all solvent The United States bankruptcy law is firms should have unfettered access to designed to provide relief from creditor Chapter 11. Despite the absence of an pressures for debtors with cash flow express financial eligibility requirement in difficulties, even where they are clearly the Code,5 SGL Carbon emphatically solvent under a balance sheet test.”). rejected any such proposition: Both the Bankruptcy Court and the Courts, therefore, have District Court concluded that Integrated c o n s i s t e n t l y d is m is s e d faced financial distress because it “was Chapter 11 petitions filed by losing a lot of money,” and “was financially healthy experiencing a dramatic downward spiral” companies with no need to in September 2001, and that, as a result, Integrated had gone “out of business.” We do not see how bankruptcy offers 5 Integrated any relief from this sort of Integrated unquestionably meets the distress, which has no relation to any debt express statutory requirements for owed by Integrated. That is, we can eligibility to file a Chapter 11 petition. identify no value for Integrated’s assets 11 U.S.C. § 109(d); The Bible Speaks, 65 that was threatened outside of bankruptcy B.R. 415 at 424-25.

16 by the collapse of Integrated’s business $12.6 million in stock in Del Monte Food model, but that could be preserved or Co., free of restrictions that would maximized in an orderly liquidation under otherwise have limited its value to $1.6 Chapter 11. Because Integrated’s million; and (2) limiting the landlord’s “dramatic downward spiral” does not lease termination damages under § establish that Integrated was suffering from 502(b)(6). Id. at 201 & n.5. The debtor financial distress, it does not, standing was successful on both fronts. The Del alone, establish that Integrated’s petition Monte stock was sold at a court-approved was filed in good faith. auction for $11 million, id. at 201 n.5, and the landlord’s lease claim was capped at Creditors that fear an impending $100,000, id. at 207. default may seek to protect their claims, triggering “the chaotic mix of self-help Critically, the debtor in PPI claimed repossession and judicial execution to have been insolvent. In addition to the available at state law” to which the landlord’s claims, the debtor had Bankruptcy Code provides an alternative. unsecured claims of approximately $54.6 Warren, Bankruptcy Policymaking, 92 million, dwarfing the value of its only Mich. L. Rev. at 350. The absence of an asset, the Del Monte stock. PPI, 228 B.R. insolv ency requirement encourages at 343. The landlord in PPI objected to companies to file for Chapter 11 before these claims because the debt was owed to they face a financially hopeless situation. insiders of the debtor, namely, the debtor’s SGL Carbon, 200 F.3d at 163-64. Yet this parent companies. The landlord argued is decidedly not the case here. The that these insider claims should be Bankruptcy C ourt recognize d th e recharacterized as equity interests, which unquestionable reality that “the debtor would leave the debtor solvent by simply was not leveraged” and, apart from approximately $11 million (not including the Landlord’s claim, “had no significant the landlord’s claim). Id. at 345. This debt.” JA34-35. The court’s conclusion issue, however, was not raised on appeal, that “I don’t think the Code makes any and we proceeded on the assumption that distinction” is legal error. the debtor “owed 50 million in ‘inter- company debt.’” PPI, 324 F.3d at 200 n.3. The absence of any financial Accordingly, PPI stands fo r the distress facing Integrated distinguishes the proposition that an insolvent debtor can two principal cases relied on by the file under Chapter 11 in order to maximize Bankruptcy Court and the District Court. the value of its sole asset to satisfy its In PPI, an insolvent debtor defaulted on a creditors, while at the same time availing lease with approximately $5.86 million in itself of the landlord cap under § rent remaining on the lease. 324 F.3d at 502(b)(6). 200-01. The debtor’s Chapter 11 petition purported to serve two main purposes: (1) We likewise understand In re liquidating the debtor’s sole asset, namely, Sylmar Plaza, which the Bankruptcy

17 Court considered “almost on all fours with cannot be divorced from the facts of that the situation before me,” to be a case in case, which reveal that the Bankruptcy which Chapter 11 was used to maximize Code was used to maximize value for value for creditors. The debtors in Sylmar creditors as a whole. Moreover, although Plaza owned a shopping center that was the debtors appear to have come out subject to a secure loan from the bank. solvent in Symlar Plaza, there is no The debtors experienced “cash flow indication that they would have come out problems” and ultimately defaulted on the solvent had the bank’s claim not been loan. 314 F.3d at 1072-73. Bankruptcy limited, or that solvency was a foregone allowed the debtor to sell the shopping conclusion when the petition was filed. center free and clear of the bank’s lien, In contrast, as noted above and which sale the Bankruptcy Court found to detailed below, according to schedules be in the best interest of the estate and all filed with the Bankruptcy Court, of its creditors. Id. at 1073; Supp. App. at Integrated had $105.4 million in cash and 114 (Order Authorizing Sale of Real $1.5 million in other assets at the time that Property Free and Clear of Liens at 4, In re it filed for bankruptcy, and yet the Sylmar Plaza, No. LA-99-33188-AA Landlord’s proof of claim lists the present (Bankr. C.D. Cal. Nov. 24, 1999)). discounted value of Integrated’s lease The bank did not appeal the sale obligations at approximately $26 million. order. Sylmar Plaza, 314 F.3d at 1073. I n t e g ra t e d’ s s c h e d u l e s a l s o lis t Instead, the Bank appealed from the miscellaneous liabilities of approximately confirmation of the debtor’s plan of $430,000. Thus Integrated was highly reorganization, which took advantage of a solvent and cash rich at the time of the provision in the Bankruptcy Code to bankruptcy filing. Even if the IPO class calculate the bank’s claim according to the action claim, which was capped at $25 regular interest rate, rather than the default million with Integrated’s liability limited interest rate. Id. In particular, the bank to a $5 million reserve (the balance to be objected to the fact that “the plan leaves paid by insurance) was listed at its full the [debtors] solvent while permitting them alleged value, Integrated was still solvent to avoid paying post-petition interest at the at the time of filing. default interest rate.” Id. at 1074. In light of the foregoing, we The Ninth Circuit affirmed the conclude that the collapse of Integrated’s lower court’s finding of good faith, business model does not support a finding reasoning that (1) insolvency is not a of good faith. Integrated was not suffering prerequisite to a finding of good faith, and financial distress when it filed its petition, (2) the fact that a creditor’s contractual and the rulings of the Bankruptcy Court rights are adversely affected does not by and the District Court to the contrary itself warrant a bad faith finding. Id. at constitute legal error. The failure of 1074-75. The court’s holding, however, Integrated’s business did not subject the

18 company to any pressure on the value of its that the securities class action did not place assets that could be reduced or avoided in Integrated in financial distress. When it an orderly liquidation under Chapter 11. filed its petition, Integrated had assets of Because Integrated’s economic difficulties nearly $107 million (of which $105 do not establish that Integrated was million was cash). Integrated also had suffering from financial distress, they do Directors and Officers (“D&O”) insurance not, standing alone, establish that coverage of $20 million. Although the Integrated’s petition was filed in good securities class claimed $93 million, faith. Integrated concedes in its brief that it “believed that the Securities Claim would B. be settled, likely within policy limits [i.e., On appeal, Integrated argues that its for less than $20 million].” Appellee’s Br. petition served a valid bankruptcy purpose at 33. In documents filed with the SEC, because bankruptcy “provide[d ] a including a proxy statement issued in framework for the Debtor to resolve the anticipation of a vote on Integrated’s Plan Securities Class Action.” Appellee’s Br. at of Complete Liquidation and Dissolution 8. In this regard, the Bankruptcy Court under Delaware law, Integrated stated: made no findings that are entitled to The company believes that deference. Instead the Bankruptcy Court the claims against it are merely acknowledged that Integrated without merit and intends to “offered a number of reasons for the filing d e fend this lawsuit of the bankruptcy case,” and that the court vigorously. While the “believe[d] there is validity to a number of outcome of these claims is those considerations.” (Emphasis added). currently not determinable, “[A] number of those considerations” the Company does not necessarily is less than all of those expect that the ultimate considerations, and the Bankruptcy Court costs to resolve these claims did not ide ntify wh ich pa rticular will have a material adverse considerations had merit except to stress effect on the Company’s that Integrated “was losing a lot of money.” financial position, results of Moreover, colloquially at least, stating that operations or cash flows. “there is validity to” something is not the same as saying that something is valid. James G. Regel, Integrated’s CEO, testified that the above statement was true Nevertheless, Integrated bore the when the proxy statement was filed. burden of demonstrating good faith, and Integrated offers no argument that there is no evidence in the record from circumstances surrounding the securities which a finding of good faith could be class action changed between April of made based on the pending securities class 2002, when the Board resolved to liquidate action. There is no question, for example, under state law, and October of that year,

19 when the Board decided to file under At the April 29 hearing, the Chapter 11. Bankruptcy Court suggested that the bankruptcy process facilitated the In the end, Integrated’s predictions liquidation of the securities class action. proved accurate. The securities class First, the Court reasoned that Chapter 11 ultimately voted in favor of a plan of “effectively reduced the recovery by the liquidation that capped their claims at $25 securities law claimants by treating them million. Although the plan does not like shareholders pursuant to Section resolve the securities claims, it limits 510(b).” We cannot find any evidence in Integrated’s liability for the securities class the record to support a finding that this action to a $5 million reserve. The treatment forced the securities class to securities class action will go forward, but accept the $25 million limit that the plan the class has essentially capped its recovery places on their potential recovery. Nor at $25 million (the $5 million reserve plus could counsel for Integrated and the the $20 million D&O policy). The OCESH support this finding when it was inescapable conclusion from the record is raised at oral argument. that the securities class action did not threaten any value of Integrated that Second, the Bankruptcy Court Chapter 11 seeks to preserve. This case is observed that, “[i]n a non-bankruptcy law therefore entirely distinguishable from context, the securities law plaintiffs would cases such as Johns-Manville, where the have had a very strategic advantage, debtor faced “approximately 16,000 namely so long as there was a possible lawsuits pending as of the filing date,” with recovery against the corporation, the the prospect of the “filing of an even more liquidation would be stalled indefinitely.” staggering number of suits over the course While the causal connection here may be of 20-30 years,” 36 B.R. at 729, or The more compelling, we fail to see how this Bible Speaks, where the debtor experienced observation distinguishes the securities “two types of financial difficulty: a cash class from any other typical creditor, since flow problem which prevent[ed] it from creditors often have strategic advantages meeting its current obligations” and a outside of bankruptcy that they lack inside “staggering” claim that “may well exceed bankruptcy. the value of the Debtor’s assets” and that Regardless, neithe r of the “pose[d] a threat to the Debtor’s continued B a n k r u p t c y C o u r t ’ s o b se r v a ti o n s existence,” 65 B.R. at 426. See SGL establishes that Integrated suffered Carbon, 200 F.3d at 168-69 (discussing these cases). 6

would have remained solvent even if the 6 We further note that, given the $105 securities class and the Landlord were to million in cash held by Integrated and the recover the full value of their claims ($93 $20 million in D&O coverage, Integrated million and $26 million, respectively).

20 financial distress, and neither supports a failed business.” OCESH Br. at 7. finding that liquidation under Chapter 11 Dissolution, however, is not an objective offered a reasonable chance of maximizing that can be attained in bankruptcy. Collier the value available to satisfy all of the on Bankruptcy § 727.01[3] (“After parties with an interest in Integrated’s liquidation, any dissolution of the estate. Rather than pursuing a valid corporation or partnership that the parties bankruptcy purpose, these observations desire must be effectuated under state law, suggest that Integrated filed for Chapter 11 since the Code does not provide for in part to gain a litigation advantage over d i s s o lu t i o n o f c o r p o r a t i o n s o r the securities class, a use of Chapter 11 that partnerships.”). Nor is “distribution,” we emphatically rejected in SGL Carbon. standing alone, a valid bankruptcy 200 F.3d at 167 (holding that petition was purpose. Instead, the Bankruptcy Code not filed in good faith where debtor’s sole allows for a distribution of the debtor’s purpose was “to put pressure on [a estate pursuant to a valid plan of claimant] to accept the company's reorganization or liquidation. 11 U.S.C. § settlement terms”). 1123. Antecedent to any such distribution is an inquiry whether the petition and the C. plan are filed in good faith, i.e., whether Integrated argues that its petition they serve a valid bankruptcy purpose. served three additional purposes that Neither Integrated nor the OCESH offer support a finding of good faith. As with any authority that the Code can be used to the securities class action, the Bankruptcy effectuate a liquidation that has no hope of Court did not specify which, if any, of maximizing the value of the company, 203 these asserted justifications had merit. Our N. LaSalle, 526 U.S. at 453; Toibb, 501 own review of the record convinces us that U.S. at 163, but simply facilitates none of Integrated’s proffered justifications dissolution on terms favorable to equity warrant a finding of good faith. interests. Moreover, neither Integrated nor the OCESH have identified any First, Integrated argues that Chapter efficiencies that were realized in this 11 “provide[d] an efficient procedure for bankruptcy that could not have been the dissolution of Debtor and distribution realized under Delaware law. of its assets to parties in interest.” Appellee’s Br. at 8. In the same vein, the Second, Integrated argues that OCESH argues that “[t]he Debtor’s Chapter 11 “provide[d] court oversight to Chapter 11 filing was in good faith the proposed sale of its intellectual [because] the debtor utilized the liquidation property [as well as] certain protections to provisions under Chapter 11 of the the parties [to the sale] not available Bankruptcy Code for the proper purpose of outside of Chapter 11.” Appellee’s Br. at obtaining a quick, efficient, and orderly 8. Integrated’s intellectual property assets winding down of the operations of its consist of patents, trademarks, copyrights,

21 and trade secrets related to the company’s and, but for Integrated’s petition, the products and services. There is no dispute OCESH would not have existed. But that the sale of these assets during the surely Integrated did not need Chapter 11 bankruptcy realized an additional $1 to discover that a more open and million beyond the sale that Integrated had competitive auction might increase the negotiated prior to filing its Chapter 11 price obtained for its assets. petition. Under the circumstances of this Moreover, the increase in value was case, however, this fact hardly justifies relatively insignificant, representing less invocation of Chapter 11. than one percent of Integrated’s total For one, the increase in value was a assets. Integrated’s de minimis assets result of Integrated’s failure to adequately (office equipment, inventory, etc.), by market the assets to potential bidders comparison, totaled $500,000. Further, the outside of the Board and management. 7 net gain to Integrated’s estate must also When, on the very next day after it filed its consider the fees paid from the estate to petition, Integrated moved to sell the assets the OCESH’s committee mem bers, at auction without further marketing, the attorneys, and professionals. In the end, OCESH challenged Integrated’s sale as an this case is a far cry from PPI, where an improper exercise of business judgment. insolvent debtor used Chapter 11 to True, the OCESH is “a creature of the increase the value of its sole asset by over Bankruptcy Code,” Appellee’s Br. at 31, 600 percent ($1.6 million to $11 million). That bankruptcy allowed for an additional $10 million to be paid to the creditors of 7 Although Integrated suggests that the the debtors. PPI, 324 F.3d at 201 & n.5. increase in value was realized because Finally, Integrated argues that “the Bankruptcy Code afforded Debtor Chapter 11 “enable[d] the Debtor to and the buyer protections including the establish a bar date and define the universe ability to sell free and clear of liens and of claims against it to assure that any claims, see section 363(f), and specific distributions to its creditors and evidentiary ‘good faith purchaser’ stockholders account for any inchoate findings, see section 363(m),” Appellee’s claims.” Appellee’s Br. at 8. Essentially, Br. at 30, the record provides no support Integrated argues that, through the for this assertion. For the most part, the OCESH, shareholders were able to assets were sold to the same insiders with investigate potential claims and determine whom Integrated had already negotiated a that none existed. The Bankruptcy Court sale prior to filing for Bankruptcy. The made no finding that Integrated was fact that these insiders were willing to subject to “inchoate” claims that needed to purchase the assets outside of bankruptcy be liquidated or barred, and Integrated’s undercuts any argument that the vague and passing references to potential protections of the Code affected the disputes with its shareholders is entirely purchase price.

22 insufficient to establish a good faith declare it?”). expectation that Chapter 11 protection was The far more relevant question is necessary to protect Integrated from such whether a desire to take advantage of a claims. particular provision in the Bankruptcy D. Code, standing alone, establishes good faith.8 We hold that it does not. Just as a Having determined that Integrated desire to take advantage of the protections was not in financial distress, and having of the Code cannot establish bad faith as a r e j e ct e d I n t e g r a t e d ’ s p o s t h o c matter of law, that desire cannot establish rationalizations for filing under Chapter 11, good faith as a matter of law. Given the we turn to the OCESH’s argument that truism that every bankruptcy petition seeks Integrated’s desire to take advantage of the some advantage offered in the Code, any cap on landlord claims provided by § other rule would eviscerate any limitation 502(b)(6) establishes good faith in and of that the good faith requirement places on itself. Integrated makes a similar argument Chapter 11 filings. when it states that its petition properly sought “a favorable forum for the At least one Bankruptcy Court has consideration and resolution of other dismissed for a lack of good faith a disputed claims, including the Landlord’s Chapter 11 petition seeking primarily to claim.” Appellee’s Br. at 8. cap a landlord’s claim for future rent under § 502(b)(6), In re Liberate Technologies, The Bankruptcy Court did not hold No. 04-31394-TC, 2004 WL 2008956, at that Integrated’s desire to take advantage *7-*8 (Bankr. N.D. Cal. Sept. 8, 2004), of the § 502(b)(6) cap established good and other Bankruptcy Courts have faith. Instead, the Bankruptcy Court held similarly dismissed Chapter 11 petitions that “it does not establish bad faith for a filed merely to take advantage of other debtor to file a chapter [11] case for the purpose of taking advantage of provisions which alter pre-petition rights, including 8 altering the rights of a landlord under State The law is clear that the burden is on law.” (Emphasis added). We agree. the bankruptcy petitioner to establish that Indeed, we believe it to be a truism that it its petition has been filed in good faith. is not bad faith to seek to avail oneself of a PPI, 324 F.3d at 211; SGL Carbon, 200 particular protection in the Bankruptcy F.3d at 162 n.10. The Bankruptcy Code— Congress enacted such protections Court’s statements that “it does not with the expectation that they would be establish bad faith for a debtor to,” or “I used. In re James Wilson Assocs., 965 conclude that as a matter of law, that is F.2d 160, 170 (7th Cir. 1992) (“It is not not a debilitating fact,” erroneously bad faith to seek to gain an advantage from suggest that the question before the court declaring bankruptcy—why else would one was whether bad faith, rather than good faith, had been proven.

23 singular provisions of the Bankruptcy In re HBA East, Inc., 87 B.R. 248, 262 Code. See N.W. Place, Ltd. v. Cooper (In (Bankr. E.D.N.Y. 1988). Indeed, if there re N.W. Place, Ltd.), 73 B.R. 978, 982 is a “classic” bad faith petition, it may be (Bankr. N.D. Ga. 1987) (Chapter 11 one in which the petitioner’s only goal is petition filed to invoke trustee’s avoidance to use the automatic stay provision to powers under Bankruptcy Code and to set avoid posting an appeal bond in another aside transfer); In re S. Cal. Sound Sys., court. E.g., Marsch, 36 F.3d at 828. Inc., 69 B.R. 893, 900 (Bankr. S.D. Cal. Integrated and the OCESH may 1987) (Chapter 11 petition filed to reject therefore be correct that § 502(b)(6) executory contract pursuant to 11 U.S.C. § reflects a Congressional determination that 365(a)); In re Cardi Ventures, Inc., 59 B.R. landlords stand to receive a windfall in a 18, 22-23 (Bankr. S.D.N.Y. 1985) (Chapter bankruptcy, and that landlord claims are 11 petition filed to assume and assign lease inherently speculative. Furthermore, pursuant to 11 U.S.C. § 365(f)); In re Integrated and the OCESH may be correct Nancant, Inc., 8 B.R. 1005, 1008 (Bankr. that § 502(b)(6) should operate to cap D. Mass. 1981) (Chapter 11 petition filed landlord claims, even where the only effect to have certain tax liability determined of the cap would be to transfer assets from pursuant to 11 U.S.C. § 505). For creditors to equity holders.9 Yet § example, 11 U.S.C. § 362 protects debtors 502(b)(6) and the legislative policy by staying litigation against them during underlying that provision assume the the pendency of the bankruptcy. Yet courts existence of a valid bankruptcy, which, in universally demand more of Chapter 11 turn, assumes a debtor in financial distress. petitions than a naked desire to stay The question of good faith is therefore pending litigation. E.g., Dixie Broad., 871 antecedent to the operation of § 502(b)(6). F.2d at 1026-27. As one Bankruptcy Court put it: Although the Bankruptcy Code contains many provisions that have the The protection of the effect of redistributing value from one automatic stay is not per se a interest group to an other, these valid justification for a redistributions are not the Code’s purpose. Chapter 11 filing; rather, it is Instead, the purposes of the Code are to a consequential benefit of an preserve going concerns and to maximize otherwise good faith filing. the value of the debtor’s estate. 203 N. A perceived need for the LaSalle, 526 U.S. at 453; Toibb, 501 U.S. autom atic stay, without at 163-64. Section 502(b)(6) is precisely more, cannot convert a bad faith filing to a good faith one. 9 The Landlord and Amici vigorously argue that § 502(b)(6) does not apply to a solvent debtor.

24 the sort of provision this Court had in mind Elizabeth Warren, Bankruptcy Policy, 54 when we stated: U. Chi. L. Rev. 775, 792 (1987), for the proposition that “[a]n almost axiomatic It is easy to see why courts principle of business law is that, because have required Chapter 11 equity owners stand to gain the most when petitioners to act within the a business succeeds, they should absorb scope of the bankruptcy laws the costs of the business’s collapse—up to to further a valid the full amount of their investment”); see reorganizational purpose. also 203 N. LaSalle, 526 U.S. at 453 Chapter 11 vests petitioners (characterizing one of the purposes of with considerable Chapter 11 as “maximizing property powers—the automatic stay, available to satisfy creditors”). the exclu sive right to propose a reorganization As we have explained above, in a plan, the discharge of debts, smoking gun resolution approved by the etc.— that can impose Board, and notwithstanding its strong significant hardship on financial position, Integrated authorized a particular creditors. When letter to the Landlord threatening that if it financially troub led did not enter into a settlement of the lease petitioners seek a chance to in the amount of at least $8 million, remain in business, the Integrated would file for bankruptcy so as exercise of those powers is to take advantage of § 502(b)(6), which justified. But this is not so sharply limits the amount that a landlord when a petitioner’s aims lie can recover in bankruptcy for damages o u t s id e t h ose of th e resulting from the termination of a lease. Bankruptcy Code. Taken to its logical conclusion, the SGL Carbon, 200 F.3d at 165 (emphasis OCESH’s argument is that any entity added). To be filed in good faith, a petition willing to undergo Chapter 11 proceedings must do more than merely invoke some may cap the claims of its landlord. d i s tr i b u ti o n a l m e c h anism in th e Nothing in the Bankruptcy Code or its Bankruptcy Code. It must seek to create or legislative history suggests that § preserve some value that would otherwise 502(b)(6) was meant to allow tenants to be lost—not merely distributed to a avoid their leases whenever the landlord’s d i f f e r en t s t a k e ho l d e r — o u t s i d e of state law remedy exceeds the cap under § bankruptcy. This threshold inquiry is 502(b)(6) by an amount greater than the particularly sensitive where, as here, the cost of proceeding through a Chapter 11 petition seeks to distribute value directly reorganization or liquidation. Such a rule from a creditor to a company’s would not only obviate the need for a good shareholders. See In re Telegroup Inc., faith requirem ent, b ut would be 281 F.3d 133, 140 (3d Cir. 2002) (quoting antithetical to the structure and purposes of

25 the Bankruptcy Code. III. We hold that both the District Court and the Bankruptcy Court erred as a matter of law in concluding that Integrated suffered financial distress. Although Integrated’s business model had failed, the company had no significant debt apart from the Landlord’s claim. Moreover, the record demonstrates that the securities class action did not present a significant threat to Integrated’s finances. Because Integrated was not in financial distress, its Chapter 11 petition was not filed in good faith as it cou ld no t— and did not—preserve any value for Integrated’s creditors that would have been lost outside of bankruptcy. We will therefore reverse the order of the District Court affirming the Bankruptcy Court’s denial of the Landlord’s motion to dismiss, and will remand this case to the Bankruptcy Court with instructions to dismiss Integrated’s petition.