On August 15, 2014, the US Court of Appeals for the Eleventh Circuit, in Global Energies, LLC v. Chrispus Venture Capital, LLC (In re Global Energies, LLC), ordered a bankruptcy court to vacate a final section 363 sale order, entered nearly four years ago, because newly discovered evidence indicated that certain insiders filed the Debtor's involuntary bankruptcy petition in bad faith (No. 13-11666, (11th Cir. Aug. 15, 2014)).

Wortley, Juranitch and Tarrant together owned Global Energies, LLC (Debtor), which marketed plasma screen technology. Wortley and Juranitch personally owned their shares while Tarrant owned shares through Chrispus Venture Capital, LLC (Chrispus), in which he owned a 93% interest. In 2010, due to business disagreements, Juranitch and Tarrant devised a plan, discussed over e-mail (June 17-19 E-mails), to eliminate Wortley's interest in the Debtor by filing an involuntary bankruptcy petition against the Debtor and acquiring its assets through a bankruptcy sale. Pugatch, Chrispus's bankruptcy attorney, also participated in the June 17-19 E-mails.

On July 1, 2010, Chrispus filed an involuntary bankruptcy proceeding against the Debtor. Wortley did not initially oppose the bankruptcy petition, but later suspected collusion by Tarrant and Juranitch when Chrispus showed interest in bidding on the Debtor's assets at the bankruptcy sale. Wortley moved to dismiss the case as having been filed in bad faith under section 1112(b) of the Bankruptcy Code. However, at that point, Wortley could proffer only circumstantial evidence to support his motion. Despite Wortley's requests for all documents and correspondence containing communications about the Debtor, the June 17-19 E-mails were not produced during discovery. Further, Juranitch and Tarrant falsely testified under oath that they had no conversations about a plan to file an involuntary bankruptcy petition, and Pugatch actively obstructed Wortley's efforts to obtain relevant evidence. Wortley withdrew the motion to dismiss, but before he had done so, the trustee sold the Debtor's assets to Chrispus. After Wortley withdrew the motion to dismiss, the bankruptcy court approved the sale.

About a year later, Wortley renewed the motion to dismiss based on new evidence, consisting of additional e-mails between Tarrant and Jurantech that only circumstantially supported his claim that Chrispus filed the involuntary bankruptcy petition in bad faith. Therefore, the bankruptcy court dismissed the motion with prejudice.

Wortley finally obtained the June 17-19 E-mails in a related state court litigation between the parties and filed a renewed motion to dismiss under Rule 60(b) of the Federal Rules of Civil Procedure. The bankruptcy court summarily denied the Rule 60(b) motion and the district court affirmed, holding that the new evidence was insufficient to warrant Rule 60(b) relief.

On appeal to the Eleventh Circuit, Wortley argued that he was entitled to relief under:

The Eleventh Circuit reversed and remanded, ordering the bankruptcy court to grant Wortley's Rule 60(b) motion to dismiss the case and vacate its order approving the sale of the Debtor's assets to Chrispus, without prejudice to any innocent third parties, whose rights and interests were derived from, and dependent on, the sale.

To prevail on a Rule 60(b)(2) motion, a movant is required to show that:

First, the Eleventh Circuit held that the bankruptcy court committed clear errors of judgment by applying a wrong legal standard to Wortley's Rule 60(b) motion and abused its discretion in doing so. Instead of examining whether the June 17-19 E-mails were new evidence, the bankruptcy court incorrectly examined whether Wortley raised new issues in his Rule 60(b) motion. The Eleventh Circuit found that the June 17-10 E-mails were new evidence for the purpose of Rule 60(b)(2) because Wortley discovered them well after the bankruptcy court denied with prejudice his motion to dismiss the bankruptcy petition.

Second, the Eleventh Circuit held that Wortley exercised due diligence by requesting the pertinent documents and then deposing Juranitch and Tarrant. In response, Pugatch falsely responded to discovery requests and Juranitch and Tarrant both lied under oath, neither of which could be attributed to Wortley's failure to exercise due diligence.

Third, the June 17-19 E-mails were direct evidence (as opposed to cumulative or impeaching evidence) that showed bad faith under all recognized bad faith tests, including:

Next, the June 17-19 E-mails were material because they clearly showed that Tarrant, Juranitch and Chrispus acted in bad faith in filing the involuntary bankruptcy petition.

Finally, the June 17-19 E-mails would have likely changed the result on Wortley's motion to dismiss the bankruptcy petition, as bankruptcy courts are entitled to dismiss a petition for "cause." The June 17-19 E-mails demonstrated bad faith and constituted cause to dismiss Chrispus's petition. The Eleventh Circuit held alternatively that the bankruptcy court could have reconsidered the sale, reversed the finding that the sale occurred in good faith under section 363(m) of the Bankruptcy Code and voided the sale.

Given that the Eleventh Circuit decided that the bankruptcy court abused its discretion in denying Wortley's Rule 60(b)(2) motion, it did not consider his alternative argument under Rule 60(b)(3).

This decision serves as a reminder that purchasers of assets in bankruptcy, especially insiders, and innocent third parties, cannot always rely on the protections of section 363(m) of the Bankruptcy Code, which provides that a sale to a good faith purchaser cannot be modified or overturned unless the sale is stayed while the appeal is pending. In this case, after discovering insider misconduct, the Court had no trouble unwinding a sale that occurred almost four years earlier, without even having to consider whether the sale occurred in good faith. However, the decision did not provide any guidance on how innocent third parties, such as lenders financing the sale, should be protected when the actual sale is vacated. Instead, the Court focused on ensuring that the parties who acted in bad faith not profit from their misconduct and abuse of the bankruptcy process.

In addition, this decision clarifies what may constitute "bad faith" in the context of filing an involuntary bankruptcy petition and should be considered by creditors seeking to use this strategy with the goal of taking control of the debtor or obtaining a strategic advantage.

For more information on section 363 sales, see Practice Note, Buying Assets in a Section 363 Bankruptcy Sale: Overview.

For more information on involuntary bankruptcy, see Practice Note, The Involuntary Bankruptcy Process.