Left to right: Andrew Kassner and Joseph Argentina of Drinker Biddle & Reath.

The U.S. Bankruptcy Code provides distressed companies an array of tools to reorganize their business affairs and restructure their debt. These powers include, among other things, the imposition of the automatic stay, centralizing most disputes in the bankruptcy court, the ability to sell assets free and clear of interests, the ability to reject burdensome contracts, and the authority to obtain a discharge if the debtor complies with the code's requirements. However, not everyone is entitled to file a bankruptcy case and obtain access to such relief. To utilize the process, a debtor must file the case in good faith. The term “good faith” is not defined in the code. Courts have interpreted good faith to mean the case must have a valid reorganization purpose. This issue was addressed in a recent decision issued on Feb. 13, by U.S. Bankruptcy Judge Laurie Selber Silverstein of the District of Delaware in In re Rent-A-Wreck of America, Case No. 17-11592. In a detailed 36-page opinion that thoroughly reviewed the record and case decisions regarding the good-faith requirement, the court held the debtors were not in financial distress at the time of the filing and filed the cases as part of a continuing two-party dispute with a franchisee, and directed dismissal of the cases for lack of good faith.

The Dispute

The opinion details a decade-long dispute between the debtors in the cases, Rent-A-Wreck of America Inc. (RAWA) and its wholly owned subsidiary, Bundy American (Bundy, and together with RAWA, the debtors), and David Schwartz, the founder and prior owner of Bundy Rent-A-Wreck. Schwartz first started using that name in 1973 in connection with his car sales business in Los Angeles. There was no formal franchise agreement between RAWA and Schwartz. RAWA thereafter went public. At the time of the opinion, there were 76 Rent-A-Wreck franchises in 28 states, plus operations in St. Maarten and Scandinavia. In addition, Bundy had between four and six nondebtor subsidiaries that operated rental franchises and related businesses.

RAWA was acquired by J.J.F. Management Services Inc. in 2006 when JJFMS purchased all outstanding RAWA stock and took RAWA private. At the time of issuance of the opinion, RAWA was part of a group of private companies owned by JJFMS. JJFMS's primary principal, John J. Fitzgerald Jr., was an owner, the president, CEO, and chairman of the JJFMS board of directors, and director and chairman of RAWA's board of directors.

After the sale closed, RAWA wrote Schwartz demanding that he either provide evidence of a franchise agreement or that he stop holding himself out as a RAWA franchisee. In June 2007, Schwartz sued RAWA, Bundy, and JJFMS in the U.S. District Court for the District of Maryland, seeking a declaratory judgment that Schwartz had a royalty-free Rent-A-Wreck franchise pursuant to a 1985 agreement or, alternatively, that he had an implied-in-fact contract based on a course of conduct between 1977 and 2007. RAWA and Bundy counterclaimed, seeking a declaration that any franchise agreement could be terminated or was an unlawful restraint on trade. After two jury trials, motions for judgment notwithstanding the verdict, and two decisions issued by the U.S. Court of Appeals for the Fourth Circuit on appeal, it was adjudicated that Schwartz did indeed hold 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 precise terms of the contract were left for further negotiation or litigation. RAWA was later held in contempt by the Maryland court for intentionally diverting prospective customers from Schwartz's business when RAWA's call center told prospective customers that there was no franchise in Los Angeles. The court's opinion states that the Maryland court observed in one of its opinions that Fitzgerald proclaimed at the outset of the litigation the he would make Schwartz “sweat at virtually every stage of the proceedings.”