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In re Rent-A-Wreck of America, Inc.

United States District Court, D. Delaware

February 5, 2019


          Scott T. Earle, Esq., Zarwin Baum DeVito Kaplan Schaer Toddy, P.C., Wilmington, DE; Roger C. Simmons, Esq. (argued), Jacob I. Weddle, Esq., Charles E. Remus II, Esq., Gordon & Simmons, LLC, Frederick, MD, attorneys for Appellants David Schwartz and Rent A Wreck, Inc.

          Mark Minuti, Esq., Saul Ewing Arnstein & Lehr LLP, Wilmington, DE; Faye B. Feinstein, Esq. (argued) and Christopher Combest, Esq., Quarles & Brady LLP, Chicago, IL, attorneys for Appellees, Rent-A-Wreck of America, Inc., Bundy American, LLC, and Quarles & Brady LLP.



         Presently before the Court is the appeal (D.I. 1) of Appellants Rent a Wreck, Inc. and David S. Schwartz (together, "Schwartz") from a Bankruptcy Court Order dated May 17, 2018 (B.D.I. 241)[1] ("Order"), which denied Schwartz's motion for sanctions (B.D.I. 237) ("Sanctions Motion") against Rent-A-Wreck of America, Inc. ("RAWA") and Bundy American, LLC ("Bundy," and, together with RAWA, "Debtors") and their counsel, Quarles & Brady, LLP ("Q&B"). Following discovery and a two-day evidentiary hearing, the Bankruptcy Court dismissed the Debtors' Chapter 11 cases for failure to satisfy the good faith filing doctrine, In re Rent-A-Wreck of America, Inc., 580 B.R. 364 (Bankr. D. Del. 2018) ("Dismissal Opinion"). Based on the dismissal, Schwartz filed the Sanctions Motion seeking an order imposing sanctions against Debtors and Q&B pursuant to Federal Rule of Bankruptcy Procedure 9011 ("Bankruptcy Rule 9011").[2] Following another evidentiary hearing, the Bankruptcy Court issued a bench ruling exercising its discretion to deny the Sanctions Motion, finding that the Debtors' Chapter 11 filing was not patently unmeritorious or frivolous or made for improper purposes of delay, harassment, or to increase costs. (B.D.I. 243, 5/17/18 Hr'g Tr. at 36:2-43:7). For the reasons set forth below, the Order is affirmed.

         I. BACKGROUND

         A. Pre-Petition Litigation

         Schwartz concedes that the Dismissal Opinion accurately recites the extensive history between Schwartz, RA WA, and Q&B throughout roughly ten years of litigation in the United States District Court for the District of Maryland and the United States Court of Appeals for the Fourth Circuit. (D.I. 12 at 4). A brief summary of the relevant background follows.

         Bundy sells and administers franchises for the "Rent-A-Wreck" vehicle rental businesses inside and outside of the U.S. and is the operating subsidiary of RAWA. RAWA is a holding company that also runs the reservation system for Bundy and other non-debtor affiliated entities. RAWA and Bundy are part of a larger group of private companies owned by J.J.F. Management Services, Inc. ("JJFMS"), whose primary principal is John J. Fitzgerald, Jr. Fitzgerald is an owner, president, CEO and chairman of JJFMS's board and also director and chairman of RAWA's board. RAWA's officers and directors are associated with JJFMS.

         Schwartz began the business under the name "Bundy Rent-A-Wreck" in 1973 in connection with his auto sales business in Los Angeles. In 1977, Schwartz and another investor created the predecessor to Bundy for the purpose of offering Rent-A-Wreck franchises. The Rent-A-Wreck mark was assigned to Bundy, and the Los Angeles County territory was excepted from the assignment. Years later, Bundy, now a wholly-owned subsidiary of then-publicly owned RAWA, ran the Rent-A-Wreck franchise system and managed the mark in all locations except Los Angeles. The relationship between Rent-A-Wreck and Schwartz was unorthodox as there was never a formal, executed franchise agreement, and, while RAWA imposed certain requirements upon its franchisees, Schwartz did not abide by those requirements at his Los Angeles location. In 2006, JJFMS completed the purchase of all outstanding RAWA stock and took RAWA private. Before the sale closed, Schwartz filed two lawsuits against RAWA challenging the sale. In October 2006, RAWA (now owned by JJFMS) wrote Schwartz demanding that he either provide evidence of a franchise agreement or that he stop holding himself out as a RAWA franchisee. RAWA removed the Los Angeles location from its website.

         On June 25, 2007, Schwartz sued RAWA, Bundy, and JJFMS, commencing the Maryland District Court litigation presided over by the Honorable Peter J. Messitte. After two jury trials and two Fourth Circuit decisions, it has been determined that Schwartz has an implied-in-fact royalty- and fee-free franchise agreement to run a Rent-A-Wreck used car rental business in West Los Angeles for his lifetime. The exact terms of the implied franchise agreement are undetermined. Schwartz does not have to comply with RAWA's fleet requirements, and RAWA must keep the Los Angeles location on its website. A 2011 order provides: "[RAWA's] Call Center shall in no way attempt to dissuade prospective customers from connecting with [Schwartz's] business or in any way attempt to divert business from Plaintiffs' exclusive business territory to other franchises." (D.I. 16 at 520-21). Otherwise, the obligations of the parties remained unsettled, and further litigation followed. On June 29, 2017, Judge Messitte found that RAWA "deliberately directed or permitted their call center operators to advise prospective customers that Rent-A-Wreck had no franchise" in West Los Angeles, and this conduct served as the basis for finding RAWA in contempt of a 2011 Order (id. 578-81) ("Contempt Order"). The Contempt Order provided injunctive relief "in light of RAWA's consistent efforts to undermine Schwartz's business" and awarded Schwartz $83, 620.80 in fees, costs, and damages. (Id. at 581).

         B. Motion to Dismiss Chapter 11 Petitions

         A month after the Contempt Order was issued, on July 24, 2017, Debtors filed voluntary Chapter 11 petitions. Debtors were granted postpetition financing on interim and final bases. (See D.I. 15 at 164, 386). On September 1, 2017, Debtors filed a motion to reject seven franchise agreements, including Schwartz's agreement. (B.D.I. 91). Schwartz opposed the rejection motion and filed separately the Dismissal Motion, seeking to dismiss the Chapter 11 cases on the basis that the petitions were filed for the improper purpose of rejecting his franchise agreement and were not filed in "good faith" within the meaning of case law interpreting § 1112(b) of the Bankruptcy Code. (B.D.I. 116). The Bankruptcy Court entered an order granting the rejection motion as to six franchise agreements and deferred a ruling on the motion as it related to Schwartz's franchise agreement so that it could be heard together with the Dismissal Motion. (B.D.I. 118).

         A Chapter 11 case may be dismissed for cause. 11 U.S.C. § 1112(b). The Third Circuit has held that § 1112(b) imposes a good faith standard. In re SGL Carbon Corp., 200 F.3d 154, 160-62 (3d Cir. 1999). However, it is a non-statutory, judge-made doctrine, and the term "good faith":

Though it suggests that the debtor's subjective intent is determinative, this is not the case. Instead, the "good faith" filing requirement encompasses several distinct, equitable limitations that courts have placed on Chapter 11 filings. Courts have implied such limitations to deter filings that seek to achieve objectives outside the legitimate scope of the bankruptcy laws. Pursuant to § 1112(b), courts have dismissed cases filed for a variety of tactical reasons unrelated to reorganization.

SGL Carbon, 200 F.3d at 165 (quoting In re Marsch, 36 F.3d at 825, 828 (9th Cir. 1994)). When a motion to dismiss a bankruptcy case is filed, the burden is on the petitioner to establish by a preponderance of the evidence that good faith exists. In re Tamecki, 229 F.3d 205, 207 (3d Cir. 2000). "Whether petitioner has met the burden is a 'fact intensive inquiry' in which a court must examine 'the totality of facts and circumstances' and determine where 'a petition falls along the spectrum ranging from the clearly acceptable to the patently abusive.'" In re Integrated Telecom Express, Inc., 384 F.3d 108, 118 (3d Cir. 2004) (quoting SGL Carbon, 200 F.3d at 162). While there is no definitive list of factors, the Third Circuit focuses on two inquiries "particularly relevant to the question of good faith: (1) whether the petition serves a valid bankruptcy purpose, e.g., by preserving a going concern or maximizing the value of the debtor's estate, and (2) whether the petition is filed merely to obtain a tactical advantage." Id. at 119-21. The Third Circuit has also instructed that to be filed in good faith, a petition must do more than merely invoke some distributional mechanism in the Bankruptcy Code: "[i]t must seek to create or preserve some value that would otherwise be lost - not merely distributed to a different stakeholder - outside of bankruptcy." Id. at 129.

         In opposing the Dismissal Motion, the Debtors bore the burden of establishing by a preponderance of the evidence that the petitions had been filed in good faith. Relying primarily on In re PPI Enterprises (U.S.), Inc., 228 B.R. 339 (Bankr. D. Del. 1998), aff'd 324 F.3d 197 (3d Cir. 2003), Debtors argued their petitions were filed for valid bankruptcy purposes of: maximizing the value of their trademarks by rejecting underperforming or burdensome agreements; eliminating the risk of further litigation with Schwartz; and relieving their balance sheet of significant debt. (B.D.I. 161). Schwartz challenged the Debtors' good faith on the basis that the Debtors were not in financial distress and filed their Chapter 11 petitions for the improper purposes of harassment and delay. (B.D.I. 116). An evidentiary hearing was held, at which three witnesses testified. (B.D.I. 187, 188). The parties made post-trial submissions. (B.D.I. 196, 197).

         On February 13, 2018, the Bankruptcy Court issued the Dismissal Opinion. Reviewing controlling Third Circuit law, the Bankruptcy Court noted that while a desire to invoke the powers conferred by the Bankruptcy Code does not establish a good faith, nor does it constitute a valid bankruptcy purpose. Rent-A-Wreck, 580 B.R. at 374 (citing Integrated Telecom, 384 F.3d at 127-28 ("Just as a desire to take advantage of the protections of the Code cannot establish bad faith as a matter of law, that desire cannot establish good faith as a matter of law. Given the truism that every bankruptcy petition seeks some advantage under the Code, any other rule would eviscerate any limitation that the good faith requirement places on Chapter 11 filings") (emphasis in original)). Otherwise, "any entity willing to bear the cost of a bankruptcy filing could use the Bankruptcy Code's redistributive mechanisms to its advantage, a concept 'antithetical to the structure and purposes of the Bankruptcy Code.'" Id. at 375 (quoting Integrated Telecom, 384 F.3d at 129). The Bankruptcy Court further stated, "The ability to use the redistributive provisions of the Bankruptcy Code assumes the existence of a valid bankruptcy, 'which, in turn, assumes a debtor in financial distress.'" Id. (quoting Integrated Telecom, 384 F.3d at 128). "Thus, good faith is a predicate to a debtor's ability to use provisions of the Bankruptcy Code, and financial distress is a part of- if not itself a predicate to - a good faith analysis." Id.

         Following a detailed and thorough analysis of the evidence offered by Debtors, the Bankruptcy Court made several findings with respect to the Debtors' financial condition.[3] Based on the record, the Bankruptcy Court "[could] not conclude that Debtors were in financial distress when they filed their petitions." Id. at 382. The Bankruptcy Court found that the Debtors "were solvent, they were not facing pressure from unaffiliated creditors nor material litigation. It is unclear whether Debtors were cash flow positive or not. The cursory testimony offered by Debtors' witnesses on this point only leaves questions, particularly after reviewing the documentary information in the record." Id. at 382. The Bankruptcy Court concluded, "The lack of credible facts demonstrating financial distress supports a finding that these cases were not filed in good faith." Id.

         The Bankruptcy Court reviewed the validity of the reorganizational purposes asserted by the Debtors and determined that the non-financial evidence also did not support a finding of good faith. The Bankruptcy Court found that the "primary purpose" of the bankruptcy filing was to reject Schwartz's franchise agreement and "open the Los Angeles territory to multiple royalty-paying franchisees." Id. The Bankruptcy Court found that the Debtors did not have to file the cases to relieve their balance sheet of secured debt, which matured six years earlier and was owed entirely to JJFMS, nor to relieve unsecured debt, the vast majority of which was owed to affiliates. The Bankruptcy Court also found that the filing would not eliminate further litigation with Schwartz; rather, the filing "has accelerated it." Id. at 386. "Debtors are simply continuing their prepetition litigation in another forum." Id. The Bankruptcy Court found that the filing was "nothing more than a straightforward attempt to take value that belongs to Schwartz and give it to Bundy," and thus the filing did not create or preserve value for creditors that would otherwise be lost outside of bankruptcy. See Id. at 383. The Bankruptcy Court described the case as "a prime example of the situation the Third Circuit warned against: the use of the Bankruptcy Code - and, in particular, its redistributive provisions - when a party is willing to pay the freight of a bankruptcy case," and concluded that the "bankruptcy petitions fall on the dark side of the spectrum ranging from the clearly acceptable to the patently abusive." Id. at 386-88. Based on the totality of the circumstances, the Bankruptcy Court ruled that Debtors had not carried the burden of proving that the cases were filed in good faith, including that the Debtors were in financial distress, and entered the Dismissal Order. (B.D.I. 222).

         C. Sanctions Motion

         On April 17, 2018, Schwartz filed the Sanctions Motion against Debtors and Q&B pursuant to Bankruptcy Rule 9011. Appellants acknowledged that the Sanctions Motion was based on the findings set forth in the Dismissal Opinion and offered no new evidence in support of the Sanctions Motion. (See D.I. 12 at 4; 5/17/18 Hr'g Tr.). Following oral argument, the Bankruptcy Court exercised its discretion not to impose sanctions. (5/17/18 Hr'g Tr. at 36:2-43:7). After identifying the relevant legal standards for evaluating the petitions under Bankruptcy Rule 9011, the Bankruptcy Court could not conclude that "no attorney or client would have found the bankruptcy filing justifiable." (Id. at 40:9-22). Because Appellants did not establish that the petitions were "patently unmeritorious or frivolous," see Dura Sys., Inc. v. Rothbury Inc., Ltd.,886 F.2d 551, 558 (3d Cir. 1989), the Bankruptcy Court declined to find that the petitions had been filed for an improper purpose. (Id. at 41:15-19). The Bankruptcy Court noted that the stringent standard governing the imposition of sanctions under Rule 11 contrasts sharply with the wide discretion afforded to bankruptcy courts to weigh ...

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