To facilitate the sale of a debtor’s dental practice, a chapter 7 trustee sought issuance of a noncompetition injunction against the debtor. The bankruptcy court declined to issue an order, and the trustee appealed to the district court.
The debtor was a practicing dentist. After he filed a chapter 7 bankruptcy petition, his shares in a professional corporation transferred to the chapter 7 trustee. Although the professional corporation eventually ceased operations, the debtor continued practicing in the same location, using the same equipment and treating the same patients.
The trustee wanted to sell the professional corporation, but claimed he could not because the debtor (1) would not cooperate in providing information about the practice, and (2) depressed the value of the corporation by operating a new dental practice in the same old location. So, the trustee sought an injunction pursuant to sections 105(a) and 521(a)(3) of the Bankruptcy Code to (a) prohibit the debtor from interfering with the sale, (b) require the debtor’s cooperation, and (c) restrict the debtor from operating a dental practice within 15 miles of the existing location for five years in order to protect the purchaser of the professional corporation from competition.
There was no question about the power of the bankruptcy court, rather the court simply exercised its discretion in declining to issue an order. So, the district court reviewed the bankruptcy court’s decision for abuse of discretion.
The trustee argued that the bankruptcy court should have issued an order precluding the debtor from practicing within 15 miles of his old practice for five years as a means to enforce the debtor’s obligation to assist in the liquidation of assets of the bankruptcy estate. He also noted that the order was authorized because applicable state law recognized an implied covenant not to compete in connection with sales of businesses.
The bankruptcy court considered the trustee’s request to be a motion for an order under section 105, which authorizes a court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code].” The court noted that while this was a broad section it did not give courts “a roving writ, much less a free hand” to grant equitable relief. Rather, the equitable remedy must be “necessary to preserve an identifiable right conferred elsewhere in the Bankruptcy Code.”
In that regard, section 521(a)(3) imposes a duty on a debtor to cooperate as necessary so that the trustee can perform its duties. The trustee interpreted this meant to mean that if a trustee asked for assistance the debtor is required to respond as long as the request is not unreasonable.
The court acknowledged cases where a debtor was required to convey estate property to the trustee and to provide information necessary to collect and liquidate the bankruptcy estate’s assets, but also noted cases in which a debtor was not required to take steps that would increase the value of the estate. As a matter of principle, courts must maintain the balance between creditors’ right to repayment and the debtor’s right to a fresh start in determining which actions the debtor may be required to take.
The trustee relied heavily on a Seventh Circuit case upholding a court order barring a former president and shareholder of a debtor corporation from competing with the debtor for a reasonable time. However, the court noted that the Seventh Circuit decision was based on the fact that equity required the president to be subject to a noncompetition order after requiring employees to sign covenants not to compete. The decision did not even consider whether the order could be justified as enforcing a duty to cooperate.
The district court acknowledged that the goodwill of the dental practice was property of the bankruptcy estate and the debtor’s competition undermined the value of the goodwill. Further, some of the debtor’s activities weighed in favor of issuing an order. Apparently, he repeatedly failed to cooperate with the trustee, and by operating his new practice in the same old location it was easy to poach the professional corporation’s clients. Accordingly, it would have been within the bankruptcy court’s discretion to issue a noncompetition order.
However, the district court was concerned by the broad geographic scope and long time period of the noncompetition restriction. Further, by the time the trustee sought this order the debtor had already been practicing for four years. So, issuing a noncompetition order would give the professional corporation the benefit of goodwill the debtor generated after his bankruptcy discharge.
Accordingly, the district court affirmed the decision because it was not an abuse of discretion for the bankruptcy court to decline to issue the requested noncompetition order.
It seems likely that the primary deciding factor was the fact that the debtor had already been practicing in the original location for four years, since an overly broad covenant not to compete could have been addressed by revising the scope. In hindsight it seems obvious that protecting the value of a business based on service of customers by the debtor requires attention early in the case to prevent the debtor from poaching the customers. Something to keep in mind.
Vicki R Harding, Esq.