Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—Bankr. M.D. Pa.: Bankruptcy filing by guarantor of franchise agreement was made in good faith, (Oct 16, 2014)

By Edward L. Puzzo, J.D.

A bankruptcy petition filed by the guarantor of a franchise agreement, the subject of litigation in another forum for breach of contract, was made in good faith and should not be dismissed, the federal bankruptcy court in Harrisburg, Pennsylvania has ruled (In Re: Zaver, October 15, 2014, France, M.).

Debtor Navnitlal Zaver had been involved in the lodging business for over 30 years and had financial interests in over a dozen franchised hotels and motels in the Harrisburg, Pennsylvania area. Among other interests, Zaver was a guarantor of a franchise agreement between franchisor G6 Hospitality Franchising and franchisee HI Hotel Group.

G6, successor to Motel 6 Franchising, alleged that HI Hotel Group had continued to use the Motel 6 trademark after it had lost its rights to do so, and then sold the business to another entity, which continued to use the Motel 6 trademark without authorization. Consequently, G6 asserted breach of contract and Lanham Act claims in federal district court against Zaver and other defendants. On the morning the lawsuit was scheduled to go to trial in 2013, Zaver filed a Chapter 13 bankruptcy petition. G6 moved to have Zaver’s bankruptcy petition dismissed. The court ruled against the motion to dismiss, finding that the bankruptcy petition had been filed in good faith.

Bad faith. The court explained that a Chapter 13 bankruptcy might be dismissed on the basis of debtor’s lack of good faith. In the Third Circuit, the factors used in making a determination of good faith included: the nature of the debt, the timing of the petition, how the debt arose, the debtor’s motive in filing the petition, how the debtor’s actions affected creditors, the debtor’s treatment of creditors both before and after the petition was filed, and whether the debtor has been forthcoming with the bankruptcy court and the creditors.

Of those factors, the timing of the petition was the initial factor to consider here. Filing bankruptcy while litigation is pending in another forum does not necessarily constitute bad faith, the court stated, but suspicious timing of a petition may be considered in a bad faith analysis. Where the purpose of the bankruptcy filing is to defeat litigation in another forum without a reorganization purpose, bad faith may be found, according to the Third Circuit. Bad faith may also be found when the debtor is not candid with the court or creditors regarding the debtor’s financial affairs.

Here, G6 alleged, Zaver’s bankruptcy petition was made in bad faith due to the timing of the petition and the undervaluation of his assets in his filing schedules.

Timing of petition. The evidence indicated that the G6 lawsuit was Zaver’s primary motivation for his bankruptcy filing, the court stated. He filed the bankruptcy petition the day the trial was to commence and after settlement negotiations collapsed. Further, there were statements Zaver made in correspondence indicating his willingness to dismiss the bankruptcy filing if the G6 litigation were to be settled. Nevertheless, the court concluded that, while the G6 suit undoubtedly precipitated Zaver’s bankruptcy filing, his involvement in numerous hospitality industry ventures, coupled with his significant reduction in income, supported his contention that he needed bankruptcy relief and intended to reorganize his financial affairs.

Value of assets in petition. In 2009, when HI Hotel Group was seeking its Motel 6 franchise, Zaver submitted a financial statement to Motel 6 Franchising setting forth the value of his interests in parcels of undeveloped land and in other lodging enterprises. G6 pointed out that the values Zaver listed in the 2009 financial statement were significantly higher than the values listed for those same assets in Zaver’s bankruptcy petition. This was evidence of bad faith, G6 argued, supporting dismissal of the bankruptcy petition.

The court conceded that there was a significant reduction in the stated value of debtor’s assets between 2009 and the 2013 bankruptcy filing. Zaver admitted that the 2009 values were not based on appraisals, and he attributed the significant reduction in values between 2009 and 2013 to the recession. Nevertheless, the court stated that there was insufficient evidence to determine whether the differences were attributable to an undervaluation of the assets in the 2013 bankruptcy schedules, an overvaluation of the assets in the 2009 financial statement, or a precipitous decline in value between those two years. In the absence of more persuasive evidence, the court concluded that Zaver did not misrepresent the value of his assets in his filing schedules.

Reorganization purpose. In the Third Circuit, the court stated, the filing of a bankruptcy petition without a reorganization purpose to defeat litigation in another forum was evidence of bad faith. The court noted that in his petition, Zaver proposed to continue making payments to his mortgage and vehicle lenders, and to restructure the debt secured by another property by paying the balance in full at a reduced interest rate, due to a significant reduction in income. Zaver thus demonstrated to the satisfaction of the court that he was using the bankruptcy process to reorganize his financial affairs.

Treatment of creditors. The court noted that Zaver generally paid creditors to whom he owed a direct obligation in a timely manner, but was not as diligent regarding obligations, such as that to G6, for which he was a guarantor. The court also noted that the payments in his proposed plan were “rather paltry” considering the assets he proposed to retain. Nevertheless, the court concluded that his actions were not so egregious as to support dismissal of the case.

The case is Civil Action No. 1:13-bk-04887 MDF.

Attorneys: Robert E. Chernicoff (Cunningham and Chernicoff PC) for Navnitlal B. Zaver.

Companies: G6 Hospitality Franchising LLC; G6 Hospitality IP LLC; Motel 6 Operating LP.

Cases: FranchisingDistribution PennsylvaniaNews