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Docket Number

Bankruptcy No. 92-42256-2-9.

Attorney(S)

C.E. Weedman, Jr., Harrisonville, Mo., for debtor. Lisa S. Van Amburg, St. Louis, Mo., Creditors Committee. Steven Block, Kansas City, Mo., for Hettie Standley, Ruthann Burgess, Dora Kiely, Jana Klein and Marilyn Schoppenhorst, Judgment Creditors. Gary D. Barnes, Kansas City, Mo., for Unsecured Creditors Committee.

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Smart Summary

Memorandum Opinion Summary: In re Chilhowee R-IV School District, Case No. 92-42256-2-9 (W.D. Mo., Oct. 8, 1992)

Factual and Procedural Background

The Chilhowee R-IV School District filed a Chapter 9 petition for reorganization. The district's principal indebtedness arose from a judgment in favor of five former teachers, plus attorney fees and costs, entered by the United States District Court for the Western District of Missouri, with the total judgment (including fees and costs) exceeding $200,000.00. The school district's annual budget was approximately $650,000.00. The district filed the Chapter 9 petition to avoid levy on its assets by the judgment creditors.

The five former teachers (judgment creditors) filed objections to the Chapter 9 petition on August 31, 1992. A hearing on those objections was held October 5, 1992, before Bankruptcy Judge Frank Koger. The creditors originally asserted three objections: (1) the school district was not generally authorized by the state to be a debtor; (2) the petition was filed in bad faith and the district had unclean hands; and (3) the district was not insolvent. At the hearing, counsel for the creditor teachers announced abandonment of the insolvency objection (Count III). The record contained no evidence on the state-authorization question, and the court presumed that claim was also abandoned. The hearing and evidence therefore centered on the bad faith / unclean hands objection.

The creditors sought admission of seven exhibits (numbered 2 through 8). The district objected to Exhibits 2, 3, and 6. The court sustained the objections as to Exhibits 2 and 3, overruled the objection as to Exhibit 6, and admitted Exhibits 4, 5, 6, 7, and 8. The creditors also presented the testimony of Thomas Weigand, a farmer and one of six members of the Chilhowee school board (first elected April 1989).

Legal Issues Presented

Whether the Chilhowee R-IV School District was generally authorized by the state to be a debtor (an issue raised by the creditors but apparently not pursued with evidence at the hearing).
Whether the Chapter 9 petition was filed in bad faith or with unclean hands by the school district (the principal issue tried and decided by the court).
Whether the school district was insolvent (an issue initially raised but expressly abandoned by the creditors at the hearing).

Arguments of the Parties

Creditors' Arguments (Five Former Teachers / Judgment Creditors)

The petition should be denied because the school district allegedly was not authorized under state law to be a debtor (no evidentiary development in the hearing).
The Chapter 9 petition was filed in bad faith and the district acted with unclean hands; the creditors relied on documentary exhibits and the testimony presented at the hearing to support this contention.
The district was not insolvent (this argument was abandoned at the hearing and no evidence was presented on it).

Debtor's Arguments (Chilhowee R-IV School District / School Board)

The district's actions in transferring funds among budget accounts and adjusting levies constituted prepetition planning to place the district in the best position for filing Chapter 9, but such prebankruptcy planning alone does not establish bad faith.
The school district relies on the availability of Chapter 9 relief as a lawful federal remedy; electing that remedy is not, by itself, proof of bad faith.
The district asserted that it could have levied higher amounts (figures mentioned in the record include possible levies of approximately $4.32–$4.33 or, with state approval, $5.15) but that some actions (e.g., a higher levy requiring state concurrence) were not solely within the school board's unilateral control.

Table of Precedents Cited

No precedents were cited in the provided opinion.

Court's Reasoning and Analysis

The court confined its analysis to the bad faith / unclean hands allegation because the parties had abandoned or failed to present evidence on the other asserted issues. The court reviewed the evidentiary record admitted at the hearing: five documentary exhibits (4, 5, 6, 7, and 8, after sustaining objections to 2 and 3) and the testimony of school board member Thomas Weigand.

The court found that the testimony of Mr. Weigand did not establish bad faith. The testimony showed that the school district had transferred funds from the incidental fund into the salary and equipment funds so that those funds would have more money than originally budgeted (thereby reducing the incidental fund's available balance). The testimony also showed a modest reduction in the levy from $4.06 for 1991–1992 to $4.00 for 1992–1993, yielding a budget reduction of less than $2,500. The record contained conflicting evidence or argument about the maximum levy the board could have imposed: the debtor suggested an ability to levy approximately $4.32–$4.33 on its own or, with state approval, up to $5.15, which the court used to calculate possible additional revenue in the 1992–1993 year (approximately $12,375 using the $4.33 figure or approximately $43,125 using the $5.15 figure), but also noted that the higher levy required concurrence of state authorities.

The court applied the legal principle that prebankruptcy planning or efforts to place a debtor in a favorable position before filing are not, standing alone, evidence of bad faith. The court explained that pre-filing planning becomes problematic only when it crosses into fraudulent conduct against creditors; the mere fact of arranging affairs to prepare for bankruptcy does not demonstrate the requisite inequitable intent. The opinion explicitly references a law-review-style discussion by the judge (Koger and Reynolds) on the distinction between prudent prefiling planning and fraud, treating that discussion as explanatory rather than as a binding precedent.

The court observed pragmatically that the school board was already assessing the highest levy in its county and found it unrealistic to require the district to first impose the absolute maximum levy (including actions requiring state approval) before the court would accept a Chapter 9 filing as made in good faith. Balancing the record and legal considerations, the court concluded that the movants (the judgment creditors) had not proved that the petition was filed in bad faith or with unclean hands.

The court's analysis resulted in an order overruling the creditors' objections to the Chapter 9 petition and declining to dismiss the petition.

Holding and Implications

Holding: The court overruled the creditors' objections and declined to dismiss the Chapter 9 petition filed by the Chilhowee R-IV School District. The court concluded that the creditors failed to demonstrate that the petition was filed in bad faith or with unclean hands.

Implications: The direct consequence is that the school district's Chapter 9 petition was permitted to proceed; the judgment creditors' objections based on bad faith were unsuccessful. The opinion does not announce or adopt a novel legal rule and the court did not state that its decision established any new precedent beyond its application of settled principles that prepetition financial planning, without fraud, is not per se bad faith. The memorandum opinion also constitutes the court's findings of fact and conclusions of law as required by Bankruptcy Rule 7052.

Opinion rendered by Frank Koger, United States Bankruptcy Judge (Memorandum Opinion dated October 8, 1992).

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In re CHILHOWEE R-IV SCHOOL DIST., Debtor.

MEMORANDUM OPINION

FRANK KOGER, Bankruptcy Judge

The Chilhowee R-IV School District filed a Chapter 9 Petition for Reorganization. The case was assigned to the undersigned. The major debt of the school district is a substantial judgment in favor of five former teachers together with a judgment for attorney fees and costs entered by the United States District Court for the Western District of Missouri. The total judgment including the attorney fees and costs exceeds $200,000.00. The budget for the school district annually is approximately $650,000.00. Rather than allow the plaintiffs to levy on the assets of the school district, the school district filed this petition in bankruptcy.

The immediate subject matter of this opinion is the hearing on the objections to the petition for relief filed by the aforesaid former school teachers. The objection was filed on August 31st and the hearing was held on October 5, 1992. In the objections filed by the creditor school teachers, there were three strings to their bow. First, they alleged the school district is not generally authorized by the state to be a debtor. Second, they alleged that the petition for relief was filed in bad faith and with unclean hands on the part of the school district. Third, the teachers alleged that the school district is not insolvent. At the beginning of the hearing counsel for the creditor teachers announced they were abandoning Count III of their objections as to the insolvency question. No evidence was presented on that issue. Further, there was no evidence presented by either side on the first issue, to-wit: whether or not the school district was generally authorized by the state to be a debtor. The Court presumes that this Count is also abandoned. All of the evidence and argument was centered on the second count of the objection, to-wit: whether or not the petition was filed by the school district in bad faith and with unclean hands.

The creditor teachers sought to admit seven exhibits. These were identified as Exhibits 2 through 8. The school district objected to Exhibits 2, 3 and 6. The objections were sustained as to Exhibits 2 and 3 but were overruled as to Exhibit 6. Therefore, the creditors were able to get admitted Exhibits 4, 5, 6, 7 and 8. In addition the creditors introduced the testimony of Thomas Weigand. Mr. Weigand is a farmer and is a member of the school board. He was first elected in April of 1989. He is one of six members of the school board of the Chilhowee R-IV School District. The testimony of Mr. Weigand, while interesting, certainly did not provide a proof of background of bad faith on the part of the school district. Although this Court knows nothing of the background of this matter, it would appear that the five school teachers got into a serious controversy with the superintendent of schools at that time. That thereafter the school board apparently backed the superintendent of schools and the teachers found themselves without jobs. It was the school board's position that they had fired the teachers for cause. It was the teachers' position they were improperly fired and the jury apparently believed the teachers.

The only thing the testimony of Mr. Weigand indicated was that the school district had placed itself in the best position for the filing of a Chapter 9 petition for relief. For example, the school district had transferred funds from the incidental fund into the salary fund and into the equipment fund so that those funds would have more money than originally budgeted. The incidental fund (which would be subject to attack by the former teachers) would not have substantial funds subject to disbursal. Furthermore the testimony did show a slight reduction of apparently six cents in the levy assessed by the school board for the year 1992-1993. The school board's levy had been $4.06 for the 1991-1992 school year and was reduced to $4.00 for the 1992-1993 school year. This made a total reduction in budget of less than $2,500.00 because each penny of levy produces $412.89 theoretically but actually somewhere around $375.00 because not everyone pays their taxes when they are due.

There was some disagreement between the parties as to how much the school board could have levied if it had made a maximum potential levy. The debtor asserts that at this point the school board could have issued a $4.33 or $4.32 levy. If the state authorities determined that the school district was in trouble financially, then apparently the school district could levy a $5.15 levy. The only evidence presented indicated that the school board could take such action only with the concurrence of state officials.

Taking the first figure of $4.33 it would appear to the Court that the maximum amount over regular budget that the school board could have raised for the year would be $12,375.00. On the other hand, taking the $5.15 figure the school board could have raised approximately $43,125.00 in the year 1992-1993.

As the Court announced at the conclusion of the hearing, the Court would not dismiss the Chapter 9 petition. There are several reasons. First, the mere fact that a debtor, whether it be an individual, corporation, or school board, attempts to place itself in as good a position as it can for entering a bankruptcy situation is only one factor to be considered. The mere fact that prebankruptcy planning has occurred is not indicative of bad faith as such. It is only when the pre-bankruptcy planning leaves the stage of preparation and becomes fraud on the creditors that there is a serious problem and the issue of bad faith rears its ugly head. For a detailed discussion of this see Is Prefiling Engineering Prudent Planning Or Section 727 Fraud? (Or When Does A Pig Becomes A Hog?) Koger and Reynolds (Commercial Law League of America Journal, Winter 1988).

Admittedly, the school board does not want to pay the teachers some $200,000.00. Very few judgment debtors want to pay judgment creditors, and the fact that the school board chose to avail itself of a legal remedy afforded it by federal law is not proof of bad faith. The fact even that there might have been some other avenue open to the school board does not brand this choice as being taken in bad faith.

Finally, the school board is already assessing the highest levy in the county. To say that they had to institute the highest possible levy (requiring state approval) before taking any other action or be guilty of bad faith filing, is unrealistic. For these reasons the Court concludes that the movants have not shown bad faith in the filing of the petition for relief by the Chilhowee R-IV School District and the objections to the petition are OVERRULED.

The foregoing Memorandum Opinion constitutes Findings of Fact and Conclusions of Law as required under Rule 7052, Rules of Bankruptcy.

SO ORDERED.

IN RE CHILHOWEE R-IV SCHOOL DIST