USA – NEW JERSEY Trends and Developments Contributed by: Brett S. Theisen, John S. Mairo, Robert K. Malone and David N. Crapo, Gibbons P.C.
cuit’s more permissive approach (eg, In re Bestwall ), setting up a potentially significant circuit split. Legal standard: good faith under Section 1112 (b) The long-standing rule in the Third Circuit is that a Chapter 11 petition may be dismissed for cause under Section 1112 (b) if not filed in good faith. Though Section 1112 (b) does not enumerate “bad faith” as a cause for dismissal, case law imputes a good- faith requirement to bankruptcy filings grounded in the equitable nature of bankruptcy and Chapter 11’s underlying purposes. A filing motivated by tactical liti - gation advantage or lacking a valid bankruptcy objec - tive gives rise to a presumption of “cause” for the dismissal of the petition( LTL 1.0 , 64 F.4th at 100–01). To rebut that presumption, the debtor bears the bur - den of proving good faith by a preponderance of the evidence, and appellate review distinguishes between clearly erroneous findings of fact and de novo review of legal conclusions – good faith being an “ultimate fact”. Questions of financial distress are similarly sub - ject to fresh review on appeal (ibid at 100). Financial distress as a threshold The Third Circuit strongly signalled that a debtor must demonstrate “some degree of financial distress” to establish good faith. Without that, there’s no valid bankruptcy purpose – whether to preserve a going concern or maximise estate value (ibid at 101). Prece - dents like Integrated Telecom and SGL Carbon under- score this requirement for a good faith bankruptcy fil - ing. In other words, solvent entities may not invoke Chapter 11, in Third Circuit jurisdictions or jurisdic - tions following Third Circuit precedent on the issue, to gain litigation leverage or reduce costs, particularly absent a business-threatening crisis (ibid at 101–02). LTL Management: divisional merger + funding agreement LTL Management was created via a Texas divisive merger, whereby talc-related liabilities of Johnson & Johnson affiliates were transferred to LTL. LTL was to have been supported by a funding agreement backed by Johnson & Johnson and New Consumer, promising up to USD61.5 billion, which contained minimal con - ditions and no repayment obligations (ibid at 96–97). The Third Circuit held that such robust backstops effectively obviated any financial distress, thereby
eliminating a core predicate for Chapter 11 good faith. The motives behind the petition – asset shield - ing and liability management rather than restructuring – were insufficient to demonstrate good faith. Good intentions (eg, brand protection, global liability resolu - tion) cannot substitute for financial distress. Crucially, the court also emphasised that only LTL’s financial condition itself matters – even if upstream affiliates were troubled, LTL’s settlement-like backing by strong sponsors undercut any independent need for bank - ruptcy (ibid at 105–06). Circuit split and strategic implications By contrast, the Fourth Circuit in Bestwall rejected a mandatory distress requirement. There, a Texas Two- Step debtor backed by affiliate funding could proceed absent subjective bad faith plus futility of reorganisa - tion. (See Blair v Bestwall, LLC (In re Bestwall, LLC) , 99 F.4th 679 (4th Cir. 2024).) This divergence sets up a cir - cuit split: savvy practitioners planning Texas Two-Step restructurings must assess whether the Third Circuit’s clear requirement of distress will thwart a prospective restructuring or whether alternative tactics (restructur - ing before transfer, demonstrating real liquidity pres - sure) could survive scrutiny. Mandatory appointment of examiners: In re FTX Trading Ltd (Third Circuit, 2024) In a landmark decision, the Third Circuit held that Section 1104 (c)(2) mandates the appointment of an examiner when a party-in-interest or the US Trustee moves for one, and unsecured debts exceed USD5 million. The circuit court wrote that Section 1104’s language – “shall” – is mandatory, not discretionary. (See In re FTX Trading Ltd , 83 F.4th 212 (3d Cir. 2024).) For creditors’ attorneys, the message is clear: in most debtor cases, you must consider whether to seek an examiner, especially where asset transparency is lack - ing or internal control concerns exist. Statutory language: “shall” means mandatory Under Section 1104 (c)(2), if unsecured fixed, liq - uidated debts exceed USD5 million and there is a motion by a party-in-interest or US Trustee – and no trustee has been appointed – the statute states the court “shall order” the appointment of an examiner. The Third Circuit reaffirmed that “shall” is mandatory – courts lack discretion to deny examiner appointment
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