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Bankruptcy Appellate Panel Affirms Bankruptcy Court’s Finding that ‘Cause’ Existed under Bankruptcy Code Section 707(a) to Dismiss Corporate Contractor’s Chapter 7 Case

In re: M.P. Construction Company, Inc., an unpublished decision by the United States Bankruptcy Appellate Panel (BAP) for the Ninth Circuit, the BAP affirmed the bankruptcy court’s ruling that ’cause’ existed to dismiss a corporate debtor’s chapter 7 bankruptcy under Bankruptcy Code Section 707(a) and to impose sanctions on debtor and its counsel under Bankruptcy Rule 9011 when the debtor contractor filed a chapter 7 bankruptcy petition to try to enable it to transfer its suspended contractor’s license to a new entity formed and owned by the adult children of debtor’s principals and the debtor was not eligible for a discharge and had no assets to distribute to creditors.

Factual Background and Procedural History

In 2005, the Wongs contracted with debtor contractor, M.P. Construction Company, Inc., to remodel their home. After being paid over $1.6 million for services originally estimated to cost $995,000, debtor sued to collect approximately $75,000 in unpaid invoices. The Wongs countersued. Following a week-long arbitration, a $601,322 judgment was entered in the Superior Court in favor of the Wongs in January 2010. The unsatisfied judgment resulted in debtor’s contractor’s license being suspended by operation of law.

In July 2009, prior to the judgment being entered, a new entity named Avenue 35 Construction Co., Inc. (“Avenue 35”) was incorporated by the three adult children of debtor’s owners, Mario and Ana Piumetti. In August 2009, Avenue 35 acquired debtor’s assets for $120,000. To facilitate this transaction, Mr. Piumetti loaned each child $40,000. The $120,000 paid to debtor was then used to repay undocumented loans that Mr. Piumetti asserted he made to debtor. Mr. Piumetti then attempted to transfer debtor’s contractor’s license to Avenue 35.

Unfortunately for debtor, Cal. Bus. & Prof. Code § 7071.17(j) precludes an entity from receiving a contractor’s license if the entity’s responsible managing officer was affiliated with a judgment debtor whose license was suspended based on an unsatisfied judgment. Consequently, debtor was precluded from transferring its license to Avenue 35. Cal. Bus. & Prof. Code § 7071.17(f) however contains an exception where the unsatisfied judgment has been discharged by bankruptcy proceeding. Thus, debtor elected to file a voluntary chapter 7 bankruptcy petition on July 15, 2011. Debtor’s schedules reflected that debtor had no assets as of the petition date.

With the aid of discovery obtained through Bankruptcy Rule 2004, the Wongs filed a motion to dismiss debtor’s bankruptcy case pursuant to Bankruptcy Code § 707(a) on grounds that the petition was not filed in good faith because debtor was a corporation not entitled to a discharge and had no assets to distribute to creditors. The Wongs also sought Rule 9011 sanctions against debtor and its attorney. The bankruptcy granted the Wongs’ motion, finding that there was “absolutely…no legitimate purpose” for debtor’s petition and that the petition was only filed to benefit debtor’s principals. Debtor appealed.

Holding and Analysis

Among the issues before the Bankruptcy Appellate Panel (BAP) was whether the bankruptcy court erred when it determined that ’cause’ existed under § 707(a) to dismiss debtor’s chapter 7 case.

Section 707(a) states:
(a) The court may dismiss a case under this chapter only after notice and a hearing and only for cause, including –
(1) unreasonable delay by the debtor that is prejudicial to creditors;
(2) nonpayment of any fees and charges required under chapter 123 of title 28; and,
(3) failure of the debtor in a voluntary case to file, within fifteen days or such additional time as the court may allow after the filing of the petition commencing such case, the information required by paragraph (1) of section 521(a), but only on a motion by the Unites States trustee.

First, the BAP noted that it was undisputed that subparagraphs 1-3 of § 707(a) were not the “cause” for the dismissal of debtor’s case. However, the BAP found that it was well-settled that if the asserted ’cause” under § 707(a) was not covered by a specific provision, ie. § 707(a)(1-3), then the court was required to consider whether under the circumstances surrounding debtor’s filing there was “misconduct sufficient to constitute ’cause’ for dismissal.” In debtor’s case, the BAP found that there clearly was.

Citing the bankruptcy court’s decision, the BAP noted that chapter 7 bankruptcy relief is available for two overriding reasons: to provide the honest but unfortunate debtor a fresh start through the discharge provisions of the Bankruptcy Code, and to provide for the fair and equitable distribution of a debtor’s assets to its creditors. The BAP had no trouble agreeing with the bankruptcy court that neither reason was present in debtor’s case.

First, because debtor was a corporation it was plainly not eligible for a discharge. Second, debtor had no assets to distribute to its creditors. Accordingly, the BAP found that the bankruptcy court did not err when it found that ’cause’ existed to dismiss debtor’s bankruptcy case. The BAP also found that debtor’s bankruptcy case “was filed not for the purpose of securing bankruptcy relief for MP Construction, but for the purpose of protecting and benefitting MP Construction’s principals.”

Accordingly, the BAP affirmed the bankruptcy court’s ruling, including its award of Rule 9011 sanctions, finding that debtor’s filing was improper because debtor would not have benefitted from a bankruptcy and the filing of the case to affect a transfer of debtor’s contractor’s license was not a valid purpose.

Commentary

This case serves as a cautionary tale and reminder to debtors and their counsel of the purpose of Chapter 7 bankruptcy and the consequences of filing a bankruptcy petition for an improper purpose. The well-established purpose of a chapter 7 bankruptcy is to provide a fresh start for the honest but unfortunate debtor and to provide a mechanism for the fair and equitable distribution of the debtor’s assets to debtor’s creditors. As this case makes clear, the purpose is not to provide a tool or means for a debtor’s principals to benefit themselves. In the case of a non-individual (entity) debtor, without assets to distribute, there is no bankruptcy purpose for a chapter 7 filing given that an entity is not eligible for a bankruptcy discharge. Moreover, a Chapter 7 filing under such circumstances may likely subject both the debtor and its attorney to sanctions.

The opinion can be found at: http://cdn.ca9.uscourts.gov/datastore/bap/2013/03/05/MP%20Construction%20Memo%2012-1306%20and%2012-1307.pdf