The National Rifle Association (“NRA”), along with its wholly owned Texas subsidiary, filed for chapter 11 bankruptcy protection on January 15, 2021 in the Bankruptcy Court for the Northern District of Texas. The case already has presented several threshold issues and challenges that are of interest to both bankruptcy practitioners and the market as a whole.
According to a press release that the NRA issued on the day it filed for bankruptcy, the group is “dumping” New York, which it describes as “a corrupt political and regulatory environment.” As a result, the NRA is seeking to utilize bankruptcy procedures to reincorporate in Texas. New York attorney general Letitia James, who is leading a pending lawsuit against the NRA seeking to dissolve the organization for diverting millions of dollars away from the group’s mission, immediately responded with a statement titled: “NRA’s Financial Status Finally Matches Moral Status: Bankrupt.” The attorney general emphasized that she will not allow the NRA to “evade accountability and [her] office’s oversight.” As evidenced by the heated statements (which prompted the bankruptcy judge to ask the parties to “ratchet” things down), the NRA’s bankruptcy case is off to a rocky start and is likely to face additional legal challenges along the way as discussed more fully below.
The NRA filed its bankruptcy petition in Dallas, which has raised an initial question of whether the NRA filed in a legally proper venue. Chartered in 1871, the NRA is a not-for-profit corporation organized under New York law, and its headquarters is in Virginia. The NRA is relying on its Texas-based subsidiary—Sea Girt LLC—to file in Texas. The “affiliate rule” under the Bankruptcy Code allows related corporate entities to file bankruptcy petitions in any venue that’s available to any of the filing affiliates. Sea Girt LLC is incorporated in Texas and therefore may file in Texas; a party typically may file in any venue in which its domicile, residence, principal place of business, or principal assets, have been located for the 180-days preceding such filing. By operation of the affiliate rule, NRA also claims that it satisfies the statutory requirement to file in Texas. However, Sea Girt LLC was not created until November 2020, which is likely during the time when NRA was already contemplating bankruptcy. Opponents may argue that the subsidiary was formed for the sole purpose of creating venue and that the NRA’s connection to Texas is not substantial enough for its choice of venue to be proper. If challenged on such grounds, the bankruptcy court has the authority to transfer venue to another jurisdiction “in the interests of justice or for the convenience of the parties.”
Good faith filing (or lack thereof)
A company need not be insolvent under US law in order to file for bankruptcy; however, bankruptcy courts are empowered to dismiss bankruptcy cases if they are not filed in “good faith” (a term that is not expressly defined by the Bankruptcy Code). Opponents may question NRA’s “good faith” given the NRA’s public statements that it is “in its strongest financial condition in years.” Indeed, court papers show that NRA holds total assets of about $203 million against total liabilities of about $153 million. And while that financial strength, in and of itself, will not necessarily invalidate its bankruptcy, NRA’s public statements have caused observers to question its motivations for filing (e.g., as a litigation tactic to avoid regulatory oversight). Such statement may make the case susceptible to challenge on good faith grounds.
Police power exception to automatic stay
Even if the NRA’s choice of venue is upheld and its case is not dismissed for lack of good faith, that does not mean that the NRA will be able to block the lawsuit brought by the New York attorney general. Typically upon a bankruptcy filing, the automatic stay kicks in and halts all pending lawsuits and legal proceedings against the debtor. A key limitation on this rule, however, is the police power exception, which allows actions brought by governmental units that are enforcing their police and regulatory power to proceed notwithstanding the automatic stay. The New York attorney general’s lawsuit against the NRA will likely fall under this exception and be allowed to continue in New York. In fact, a day after the NRA’s bankruptcy filing, a New York state court overseeing the lawsuit agreed that the bankruptcy filing did not stay the lawsuit and proceeded to consider the case. The bankruptcy court has not yet opined on this issue.