Texas Bankruptcy Court Dismisses NRA Bankruptcy Cases, Finding They Were Not Filed in Good FaithMay 19, 2021 – Herrick Restructuring Review
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On May 11, 2021, Judge Harlin D. Hale dismissed the chapter 11 case filed by the National Rifle Association after finding that it was not filed in good faith. Judge Hale ruled that the case was “filed to gain an unfair litigation advantage” and to “avoid a state regulatory scheme,” which the Court found was “not for a purpose intended or sanctioned by the Bankruptcy Code.”
In August 2020, the New York attorney general (“NYAG”) filed a complaint in New York state court against the NRA seeking its dissolution (the “NYAG Enforcement Action”) based on allegations of improper use of funds and self-dealing by NRA executives, including its executive vice president, Wayne LaPierre. The NYAG has jurisdiction over the NRA because it is a not-for-profit corporation.
The NRA first challenged the NYAG Enforcement Action by seeking to have the case dismissed in the New York courts. But when that effort failed, in January 2021, the NRA and its subsidiary filed chapter 11 petitions in the Northern District of Texas. In its chapter 11 filing, the NRA stated its intention to use its chapter 11 case to reincorporate in Texas. Multiple motions to dismiss the NRA’s case as a bad faith filing were filed by a former vendor, the NYAG, and the District of Columbia Attorney General. The United States Trustee, an arm of the Department of Justice, supported the motion to dismiss.
Dismissal for Filing in Bad Faith
Although the Bankruptcy Code contains no requirement that bankruptcy petitions must be filed in good faith, most courts have held that a chapter 11 case can be dismissed due to “the lack of good faith in its filing.” In determining whether to dismiss a bankruptcy for lack of good faith, most courts apply a totality-of-the-circumstances test. While there is no specific test or exhaustive list of factors for determining bad faith, courts consider whether the debtor has shown the intent to abuse the judicial process and the purposes of reorganization.
Before the hearing on the motions to dismiss, there was extensive discovery, including the deposition of Mr. LaPierre, which provided the Court with a well-developed record to base a decision on. The Court found that the decision to file for chapter 11 was made solely by Mr. LaPierre, and that other senior officers and the board of directors of the NRA were not informed in advance, nor was there a board of directors vote on whether the NRA should file for bankruptcy.
One of the factors courts review in deciding whether to dismiss a case as a bad faith filing is whether the debtor has a bona fide need for financial reorganization. On that point, the Court found that “[t]here was a general consensus among the witnesses that, as the NRA ha[d] consistently represented to the Court and to its members, the NRA [was] in its strongest financial condition in years and intend[ed] to pay creditors all allowed claims in full.” The Court also found that the evidence “[did] not support a finding that the purpose of the NRA’s bankruptcy filing was to reduce operating costs, to address burdensome executory contracts and unexpired leases, to modernize the NRA’s charter and organization structure, or to obtain a breathing spell.” While the Court found that there was some evidence that the NRA wanted to reduce litigation costs, the Court noted that this did not appear to have been the NRA’s real purpose behind filing for bankruptcy. The Court also noted that it appeared that the NRA’s desire to leave New York and reincorporate in Texas was not the real purpose for filing for bankruptcy. The Court ultimately found that “the primary purpose of the bankruptcy filing was to avoid potential dissolution in the NYAG Enforcement Action.”
The Court’s Deference to the NYAG Enforcement Action
The Court noted that it had “great concern about this case because its purpose [was] to avoid dissolution that [was] being sought as a remedy in a state regulatory action” and that there was a difference between “a lawsuit in which a party seeks a monetary judgment that would pose an existential threat to a debtor and one where the attorney general of a state is specifically seeking dissolution of a debtor under the state’s laws and therefore required to satisfy standards and requirements that specifically justify dissolution.” (emphasis added).
The Court further stated that “[t]he purpose of this bankruptcy filing may not have been to end the NYAG Enforcement Action immediately, but it was to deprive the NYAG of the remedy of dissolution, which is a distinct litigation advantage.” Other bankruptcy courts have repeatedly held that a bankruptcy case filed for the purpose of obtaining an unfair litigation advantage is not filed in good faith.
The Court also reasoned that “[u]sing the bankruptcy process to avoid dissolution in the NYAG Enforcement Action is . . . problematic because it deprives the state of New York of the ability to regulate not-for-profit corporations in accordance with its laws.” The Court found that “[w]hile bankruptcy courts can, in some circumstances, apply state regulatory law, a bankruptcy case filed for the purpose of avoiding a regulatory scheme is not filed in good faith and should be dismissed.” (emphasis added).
Although the Court noted that it did not find that reincorporating in Texas was the true purpose of the NRA’s bankruptcy filing, the Court would have been troubled even if that had been its true purpose: “Reincorporating in Texas could be accomplished outside of bankruptcy pursuant to applicable regulations for New York not-for-profit organizations, which begs the question of what the Bankruptcy Code is being used for.”
The Court affirmed that it had “not announced a per se rule that a pending dissolution action renders an entity ineligible for bankruptcy.” Rather, the Court was “evaluating the debtor’s good faith or lack thereof in filing bankruptcy based on the totality of the circumstances of this specific case.” Based on the extensive record, the Court found that “the NRA’s bankruptcy petition was not filed in good faith but instead was filed as an effort to gain an unfair litigation advantage in the NYAG Enforcement Action and as an effort to avoid a regulatory scheme.” The Court found that this constituted cause for dismissal under section 1112(b)(1).
The Court noted that it was not dismissing the case with prejudice, but if the NRA filed a new bankruptcy case, the Court would “immediately take up some of its concerns about disclosure, transparency, secrecy, conflicts of interests of officers and litigation counsel, and the unusual involvement of litigation counsel in the affairs of the NRA, which could cause the appointment of a trustee out of concern that the NRA could not fulfill the fiduciary duty required by the Bankruptcy Code for a debtor in possession.”
The case is In re National Rifle Association of America and Sea Girt, LLC, No. 21-30085 (Bankr. N.D. Tex. May 11, 2021).
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