Current Developments in Involuntary Bankruptcy Filings

Scott E. Blakeley, Esq.

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Current Developments in Involuntary Bankruptcy Filings

SECTION 303 — INVOLUNTARY PETITIONS

1.1     General.

In evaluating various collection remedies, creditors collectively[1] may find the commencement of an involuntary chapter 7 or a chapter 11[1] to be one of the most effective tools they have against a debtor.  Involuntary proceedings may be an appealing alter­native to either an out of court workout or a state law assignment for the benefit of creditors where a debtor is, for instance, fraudulently conveying assets;[1] making preferential transfers;[1] unwilling to convey financial information;[1] or where the trade and banks are unwilling to provide additional credit to the credit.[1]

In 1978 Congress sought to liberalize the standard for initiating involuntary petitions by abolishing the “acts of bankruptcy” standard set forth in the Bankruptcy Act of 1898[1] and adopting the “general failure to pay” standard with the enactment of the Bankruptcy Reform Act of 1978 (“Bankruptcy Code” or “Code”).[1] Congress sought to accommodate the filing of involuntary petitions at earlier stages to increase the likelihood of reorgani­zation and increase the distribution to creditors.[1] To facilitate involuntary filings on a procedural basis, Congress abrogated the right to jury trial making it discretionary with the bankruptcy court.[1] Contested petitions are to be tried at the earliest possible time.[1]

To discourage frivolous filings against financially healthy debtors, and because involuntary bankruptcy is a severe remedy,[1] Congress imposed certain filing criteria on petitioners: petitioners’ unsecured claims aggregate $5,000;[1] the debtor is generally not paying its debts that are not the subject of a bona fide dispute as they come due;[1] a petitioner’s claim is not contingent as to liability or the subject of a bona fide dispute;[1] three creditors must join in petition where the debtor has twelve or more creditors[1]; the discretionary requirement of posting a bond[1]; and the fact that costs, attorney’s fees, con­sequential and punitive damages may be awarded against petitioners.[1]

Since Congress has not defined the “general failure to pay” standard, the “bona fide dispute” standard and the “bad faith” standard, nor have courts crafted bright line tests, it may be difficult for a creditor to gauge whether it, or joining creditors, have standing to commence a valid petition.  Likewise it may be difficult for a creditor to determine whether the debtor may be the proper subject of an involuntary petition.  This difficulty highlights the informational hurdles a petitioning creditor may face:  it may have insufficient information as to whether the debtor has generally defaulted on its obligations, especially if the debtor is not a public company[1]; it may have insufficient information as to whether joining petitioners’ claims are the subject of bona fide disputes.[1]

Once an involuntary petition is contested,[1] a petitioner typically faces three threshold issues:  (1) its standing: whether its claim is contingent as to liability or the subject of a bona fide dispute;[1] (2) whether the debtor is generally paying its debts as they come due;[1] and (3) whether the petition was filed in bad faith.[1]

Even if the involuntary petition is found to be properly filed, the bankruptcy court may nevertheless exercise its dis­cretion and abstain from entering an order for relief and dismiss the petition.[1] The grounds for dismissal is that it would be in the best interests of the creditors and debtors[1], or that creditors have adequate remedies under state law.[1]

The stakes for petitioners failing to carry their burden can be high.[1] If an involuntary petition is dismissed, the petitioners can be held liable for the debtor’s costs and attorneys fees.[1] Moreover, if it is found that the involuntary petition was filed in bad faith, the petitioners can be liable for actual and punitive damages.[1]

1.2     11 U.S.C. ‘ 303

(a)     An involuntary case may be commenced only under chapter 7 or 11 of this title, and only against a person, except a farmer, family farmer, or a corporation that is not a moneyed, business, or commercial corporation, that may be a debtor under the chapter under which such case is commenced.

(b)     An involuntary case against a person is commenced by the filing with the bankruptcy court of a petition under chapter 7 or 11 of this title —

(1)     by three or more entities, each of which is either a holder of a claim against such person that is not contingent as to liability or the subject of a bona fide dispute, or an indenture trustee representing such a holder, if such claims aggregate at least $5,000 more than the value of any lien on property of the debtor securing such claims held by the holders of such claims;

(2)     if there are fewer than 12 such holders, excluding any employee or insider of such person and any transferee of a transfer that is voidable under section 544, 545, 547, 548, 549, or 724(a) of this title, by one or more of such holders that hold in the aggregate at least $5,000 of such claims;

(3)     if such person is a partner­ship —

(A) by fewer than all of the general partners in such partnership; or

(B) if relief has been ordered under this title with respect to all of the general partners in such partnership, by a general partner in such partnership, the trustee of such a general partner, or a holder of a claim against such partnership; or

(4)     by a foreign repre­sentative of the estate in a foreign proceeding concerning such person.

(c)     After the filing of a petition under this section but before the case is dismissed or relief is ordered, a creditor holding an unsecured claim that is not contingent, other than a creditor filing under subsection (b) of this section, may join in the petition with the same effect as if such joining creditor were a petitioning creditor under subsection (b) of this section.

(d)     The debtor, or a general partner in a partnership debtor that did not join in the petition, may file an answer to a petition under this section.

(e)     After notice and a hearing, and for cause, the court may require the petitioners under this section to file a bond to indemnify the debtor for such amounts as the court may later allow under subsection (i) of this section.

(f)     Notwithstanding section 363 of this title, except to the extent that the court orders otherwise, and until an order for relief in the case, any business of the debtor may continue to operate, and the debtor may continue to use, acquire, or dispose of property as if an involuntary case concerning the debtor had not been commenced.

(g)     At any time after the commence­ment of an involuntary case under chapter 7 of this title but before an order for relief in the case, the court, on request of a party in interest, after notice to the debtor and a hearing, and if necessary to preserve the property of the estate or to prevent loss to the estate, may order the United States trustee to appoint an interim trustee under section 701 of this title to take possession of the property of the estate and to operate any business of the debtor.  Before an order for relief, the debtor may regain possession of property in the possession of a trustee ordered appointed under this subsection if the debtor files such bond as the court requires, conditioned on the debtor’s accounting for and delivering to the trustee, if there is an order for relief in the case, such property, or the value, as of the date the debtor regains possession, of such property.

(h)     If the petition is not timely controverted, the court shall order relief against the debtor in an involuntary case under the chapter under which the petition was filed.  Otherwise, after trial, the court shall order relief against the debtor in an involuntary case under the chapter under which the petition was filed, only if —

(1)     the debtor is generally not paying such debtor’s debts as such debts become due unless such debts are the subject of a bona fide dispute; or

(2)     within 120 days before the date of the filing of the petition, a custodian, other than a trustee, receiver, or agent appointed or authorized to take charge of less than substantially all of the property of the debtor for the purpose of enforcing a lien against such property, was appointed or took possession.

(i)     If the court dismisses a petition under this section other than on consent of all petitioners and the debtor, and if the debtor does not waive the right to judgment under this sub­section, the court may grant judgement —

(1)     against the petitioners and in favor of the debtor for —

(A) costs; or

(B) a reasonable attorney’s fee; or

(2)     against any petitioner that filed the petition in bad faith, for ‑‑

(A) any damages proximately caused by such filing; or

(B) punitive damages.

(j)     Only after notice to all creditors and a hearing may the court dismiss a petition filed under this section —

(1) on the motion of a petitioner;

(2) on consent of all petitioners and the debtor; or

(3) for want of prosecution.

(k)     Notwithstanding subsection (a) of this section, an involuntary case may be commenced against a foreign bank that is not engaged in such business in the United States only under chapter 7 of this title and only if a foreign proceeding concerning such bank is pending.

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Current Developments in

Involuntary Bankruptcy Filings

1.3     Recent Cases and Comment

FIRST CIRCUIT

LaRoche v. Amoskeag Bank (In re LaRoche), 969 F.2d 1299 (1st Cir. 1992)

(a)     Issues Presented

(1)  Whether disqualified petitioning creditor knew or should have known its claim was the subject of a bona fide dispute such that bad faith tainted the petition and barred the joinder of a subsequent petitioner; (2) whether petition is defective where officer of corporate petitioner signs the verification rather than counsel of record.

(b)     Basic Facts

Three petitioners commenced an involuntary chapter 11 petition against an individual debtor.  The bankruptcy court found one of the petitioner’s claims subject to a bona fide dispute and disqualified the petitioner.  The bankruptcy court allowed the joinder of a subsequent petitioner at the hearing and entered an order for chapter 11 relief.  The district court affirmed.  On appeal, the debtor contended that the disqualified petitioner manifested bad faith in joining the involuntary petition since it knew or should have known its claim was the subject of a bona fide dispute.  The debtor challenged the standing of another petitioner on the grounds that no proper party signed the petition.

(c)     Court’s Analysis

Where a petitioner joins a petition in good faith, but is later disqualified, the joinder of a subsequent qualified petitioner is permissible.  So long as the joinder is accomplished prior to dismissal of the petition, the defect is cured and an order for relief may be entered.

Official Form 11 and Bankruptcy Rule 9011 provide for the signing of a creditors’ petition by a lay person who is not represented by counsel.  As the executing officer was authorized to sign the petition, the signing requirements were met.

(d)     Comment

The enactment of BAFJA introduced the requirement that a petitioning creditor hold a claim that is not the subject of a bona fide dispute.[1] Neither Congress nor the legislative history define the term “bona fide dispute” but the legislative history makes clear that Congress intended to disqualify a creditor wherever there is any legitimate basis for the debtor not paying the debt, whether that basis is factual or legal.[1] The policy for excluding claims subject to a bona fide dispute is to prevent creditors from using involuntary bankruptcy as a club to coerce the debtor to pay debts as to which the debtor, in good faith, has legitimate defenses.[1] This provision is significant, as noted by the court’s holding herein, for if there is a bona fide dispute as to either law or facts, the petitioning creditor does not qualify and the petition must be dismissed[1] unless another qualified creditor is permitted to join.[1]

Courts have fashioned various tests for determining whether a claim is subject to a bona fide dispute.  The majority of courts, including the Third, Seventh, Eighth and Tenth circuits, adopt the test of whether there is a genuine issue of material fact that bears upon the debtor’s liability or a meritorious contention as to the application of law to undisputed facts.[1] Under this test, a court need not determine the probable outcome of the dispute but only whether one exists.[1] Moreover, there must be an objective basis for the dispute.[1] This test has appeal because it requires the court to undertake only limited analysis[1] and the test best effectuates Congress’ intent.[1]

The LaRoche court purports to adopt the Lough test.  LaRoche at 1304.  Yet its analysis of the dispute cannot be characterized as limited in scope; indeed, it determined the outcome of the dispute.  LaRoche at 1304-05.

A second line of authority, which has been largely shunned by courts recently, adopts a multifactor balancing test:  (a) the nature of the dispute; (b) the nature and extent of the evidence and allegations presented in support of the creditor’s claim and in support of the debtor’s contrary claim; (c) whether the creditor’s claim or debtor’s contrary claim are made in good faith and without fraud; and (d) whether on balance the interest of the creditors outweigh those of the debtor.[1] Criticism of this test focuses on the unpredictability of the result[1] and its excessively subjective slant.[1]

A third test is whether “the defense of alleged debtor to the claim of the petitioning creditor raises material issues of fact or law so that summary judgment could not be rendered as a matter of law in favor of the creditor on a trial of the claim, the claim is subject to a bona fide dispute.”[1] Courts have criticized the application of this test because Federal Rule 56 divides disputes by the existence of material facts while section 303 does not.[1]/

The LaRoche court enunciates the general rule for joinder of a creditor who replaces a petitioning creditor that is disqualified or withdraws:  at any time before a case is dismissed, qualified creditors may intervene in the involuntary petition and be treated as though they had been a petitioning creditor at the time the petition was initially filed.[1] Petitioners may solicit other creditors to join a petition so long as the petition was not filed for an improper purpose.  The Code contemplates such action with the requirement of three petitioners.[1]

The exception, which the debtor did not establish in LaRoche, is when the petition was filed in bad faith. The joinder will be disallowed and the peti­tion dismissed.[1] Here, the bankruptcy court permitted the “eleventh hour” inter­vention of a creditor at the trial as the petition had not been dismissed.[1] In permitting joinder of a substitute creditor at the involuntary trial, the court found the debtor was not prejudiced.  The debtor had not objected to the joinder on the ground of prejudice nor requested a continuance to permit discovery.[1]

It should be noted that the commencement of an involuntary petition against an individual, as was the case in LaRoche, generally does not benefit creditors as the only assets available to satisfy creditors are those that are unencumbered and nonexempt.[1] Typically, individual creditors own few nonexempt assets.  Furthermore, the individual debtor’s post-petition earnings are not property of the estate.[1] And the honest debtor is entitled to discharge its in personam obligations.[1] However, where the debtor is converting assets or conducting other bad acts, an involuntary chapter 7 petition is attractive since it provides the protection of a trustee.[1]

THIRD CIRCUIT

Landon v. Hunt, 977 F.2d 829 (3d Cir. 1992)

(a)     Issue Presented

Whether alleged creditors knew or should have known that they held no claims against debtors, or they held claims that were the subject of a bona fide dispute, and therefore demonstrated bad faith in commencing involuntary proceedings.

(b)     Basic Facts

A dispute arose between debtors and alleged creditors over ownership and commissions owing on an antique desk.  The debtors filed a declaratory relief action in the state court. One of the alleged creditors filed a separate suit in state court contending ownership of the desk.  The state court ruled in favor of the debtors.  The alleged creditor’s state court action was dismissed with prejudice.  The alleged creditors elected not to appeal either the state court rulings, but instead commenced involuntary petitions the same day as the dismissal of one of the state court actions.  The bankruptcy court found the alleged creditors had no standing as they held no claims against the debtors because of the state court rulings, and the petitions were dismissed.  Attorneys’ fees, costs and sanctions were awarded against the alleged creditors and their attorneys.  The district court affirmed.

(c)     Court’s Analysis

One of the conditions for filing a valid involuntary petition is that a petitioner hold a claim which is not the  subject of a bona fide dispute or contingent.  The record revealed that neither the alleged creditors nor their counsel had grounds to reasonably believe they held claims against the debtors when they commenced their petitions.  The state court rulings foreclosed any claims they may have had against the debtors.  An alleged creditor’s contention that the bankruptcy court was the appropriate forum to litigate its claims because of state court delay in the appeal process was unfounded.

Section 303(i)(2) provides for an award of damages proximately caused by the debtor or sanctions.  Sanctions may be awarded pursuant to Bankruptcy Rule 9011.  As the involuntary petitions were not well grounded in fact, indeed, the involuntary petitions were a “flagrant abuse of process”, the deterrent purposes of Rule 9011 would be served by sanctioning the alleged creditors and their counsel.

(d)     Comment

A petitioner must be a holder of a claim at the time the petition is filed.[1] A claim is defined broadly by the Bankruptcy Code,[1] notwithstanding the restrictions imposed by section 303.

Even if the alleged creditors in Landon had appealed the state court rulings and thereafter commenced involuntary proceedings, thereby providing grounds to assert claims, the bankruptcy court would still have had grounds to dismiss the involuntary petitions.  For instance, the alleged creditors could have their claims challenged on the grounds they are subject to a bona fide dispute since the bankruptcy court is to defer to any ruling already made in prepetition litigation.[1] Further, there is authority that the petitions were filed for an improper purpose, the substitution of customary collection practices.[1] Another ground for dismissal, presuming appeal of the state court action, would be that the nature of the dispute is better handled by the state court.[1]

Section 303(i)(1) provides that a court may enter judgment for costs and attorney’s fees, and section 303(i)(2) provides that, upon a showing of bad faith, a court may award consequential and/or punitive damages against the petitioners when the involuntary petition is dismissed other than on consent of the parties or abstention by the court.  The remedies are cumulative.[1]

Neither section 303(i)(1) nor its legislative history provide a framework to guide courts as to how it should exercise its discretion.[1] Attorney’s fees may be awarded, even in the absence of bad faith, in an involuntary case.[1]

Two lines of authority have emerged as to the appropriateness of awarding fees and costs under section 303(i)(1).  The majority view reasons that unsuccessful petitioners should generally expect that fees and costs will be awarded the debtor if the petition if dismissed.[1] However, this routine standard is tempered by the court’s balancing of such factors as the reasonableness of the petitioners’ actions, their motivation and objectives, and whether the petition was sustain­able.[1] The minority view finds that “[f]ew courts . . . have assessed costs attorney’s fees pursuant to ‘ 303(i)(1) absent a bad faith finding.[1] Criticism of this view is that the express terms of the statute provide otherwise.[1]

With respect to the amount of fees awarded, section 303(i)(1) provides for allowance of reasonable attorney’s fees.  While courts require documentation to determine the reasonableness of attorney’s fees,[1] courts have been reluctant to apply section 330 in the calculus,[1] because of the statutes’ differing standards.[1]

With respect to costs allowed under section 303(i)(1), only those costs associated with legal representation are allowed.[1] The court is not obligated to assess the award against the petitioners equally.[1] Courts are split as to whether a petitioner may set off its claim against an award of costs and attorney’s fees.[1]

The Landon court ordered petitioners and their attorney to pay debtors’ attorney’s fees and costs.  To the extent the award of attorney’s fees was not based on Rule 9011, there is no statutory support for such an award.  “Section 303 (i) provides for claims against only peti­tioners, not against their counsel.”[1] However, the debtor may look to petitioners’ counsel under Rule 9011.[1]

Section 303(i)(2) addresses the dismissal of an involuntary petition on bad faith grounds.  Neither the Bankruptcy Code nor its legislative history defines bad faith,[1] is to be determined by the facts of each case.[1] However, the historic purpose of involuntary bankruptcy is to provide creditors with a means of assuring equal distribution of the debtor’s assets.[1]

Several tests have emerged in determining bad faith.  One test measures by an objective standard, what a reason­able creditor in the position of the petitioning creditor would have done.[1] Another test applies a subjective standard, investigating the petitioning creditor’s motives.[1]

Closely aligned with the subjective standard is the evaluation of whether the petitioner was motivated by an improper purpose, such as malice or harassment.[1]

Another test measures bad faith by whether the petitioner’s motivation for filing was for an improper use of the Bankruptcy Code.[1]

Recently, a substantial majority of the courts have measured bad faith by the standards contained in Bankruptcy Rule 9011.[1] Generally, a three factor test is employed under Rule 9011:  (1) whether petitioner made reasonable inquiry of relevant facts and pertinent law before initiating petition; (2) whether petition was well grounded in fact; (3) whether petition was warranted by existing law or by good faith argument for a change in existing law.

In applying these various tests, the good faith of a petitioner is presumed and the burden of proving bad faith rests on the debtor.[1] The debtor must prove bad faith by a preponderance of the evidence.[1] Moreover, one must establish the bad faith of each petitioning creditor against whom one seeks an award of damages.[1] The Landon court found that the petitioners and their counsel had flagrantly disregarded bankruptcy law and procedure by filing petitions knowing they held no claims against the debtors and sanctions were appropriate.[1]

Upon a finding of bad faith, the court may award fees, costs, compensatory damages[1] and punitive damages[1] pursuant to section 303(i)(2). Moreover, a debtor’s remedies may extend beyond section 303(i).[1] Proof of damages need not be shown with mathematical certainty.[1] The debtor may seek to defer a hearing on damages until it can prove actual losses and anticipated damages.[1]

Some petitioners attempting to avoid a section 303(i) award, assert the debtor has waived its claim for damages where it was not raised prior to dismissal of the petition.[1] Such argument should fail.  A debtor’s responsive pleading to an involuntary petition is limited to the issues raised in the involuntary petition.  Counterclaims for damages asserted by the debtor under section 303(i) have been dismissed as premature.[1] An involuntary petition must be dismissed prior to an award of costs and damages.[1] Following dismissal a court may retain jurisdiction to award fees, costs and damages attribu­table to an unsuccessful filing.[1] Accordingly, courts have found a debtor has not waived its rights to fees where it did not put forward such evidence prior to dismissal.[1]

DISTRICT COURT

In re Secured Equipment Trust of Eastern Airlines, Inc., __ B.R. __, 1992 WL 295943 (S.D.N.Y.)

(a)     Issues Presented

(1) Whether the petitioners filed the involuntary petition in bad faith; (2) whether the bankruptcy court abused its discretion in requiring the petitioners to post a $10 million bond.

(b)     Basic Facts

Equipment trust certificate holders filed a chapter 11 involuntary petition against the debtor, a business trust.  The collateral trustee of the debtor moved for transfer or dismissal of the petition.  The request for dismissal was based on the alleged bad faith of petitioners.  The trustee contended that it would be entitled to a substantial damage award from the petitioners upon dismissal of the petition.

The bankruptcy court tentatively ruled that the debtor, because it was a business trust, was not an eligible debtor. The bankruptcy court also found bad faith since the essential purpose for the involuntary filing was the advancement of inter­creditor interests, and not the implementation of a plan of reorgani­zation.  The court ordered petitioners to post a $10 million bond to protect the debtor from the risk of damages caused by the involuntary filing.  No bond was posted and the petition was dismissed.  The petitioners appealed.

(c)     Court’s Analysis

Section 303(e) provides that a court may require petitioners to file a bond to indemnify the debtor from loss from the filing.  According to the legislative history of the provision, the bonding requirement was designed to “discourage frivolous petitions as well as the more dangerous spiteful petitions, based on a desire to embarrass the debtor … or put the debtor out of business without good cause…”  H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 323 (1977).

The district court analyzed the various standards for determining bad faith promulgated.  There was no evidence that the petitioners’ stated purpose for commencing the proceeding, the resolution of intercreditor disputes through a plan of reorganization, rose to the level of bad faith enunciated in any of the tests.  The district court vacated the orders dismissing the petition and the require­ment of posting a bond.

BANKRUPTCY LEVEL DECISIONS

In re K. P. Enterprise, 136 B.R. 174 (Bankr. D.Me. 1992)

(a)     Issues Presented

(1)  Whether solo petitioner made a reasonable investigation into the number of the debtor’s creditors before filing involuntary petition; and (2) whether the petition was filed in bad faith.

(b)     Basic Facts

The former owner of the debtor, who continued to provide certain services, was owed deferred compen­sation by the debtor. The obligation to the former owner was secured by the debtor’s assets, and subordinated to the bank.  The relation­ship between the new and former owner deteriorated.  The debtor defaulted on the bank loan.  The former owner filed an involuntary petition against the debtor.  The debtor sought dismissal, asserting that it had more than twelve creditors.

(c)     Court’s Analysis

Section 303(b)(2) provides that when a creditor has less than twelve creditors, only one petitioning creditor is necessary to file a valid petition.  Section 303(c) and Bankruptcy Rule 1003(b) provide for the joinder of additional petitioners upon a showing by the debtor that it has more than twelve creditors.  The only investi­gation the former owner made as to whether the debtor had fewer than twelve creditors was his reliance on figures generated a year before he sold the business.  The investigation was unreason­able.

Section 303(i) provides that a court may award costs and attorneys’ fees upon a dismissal of an involuntary petition.  In determining whether costs and attorneys’ fees were appropriate, the court balanced the (1) reasonableness of the petitioner; (2) the motivation and objective of the petitioner; and (3) whether the petition was proper and sustainable from the petitioner’s perspective.  These factors weighed against the former owner.  Costs and attorneys’ fees attributable to defending the involuntary petition were awarded.

The court adopted the Rule 9011 standard to determine whether the petition was filed in bad faith.  The former owner’s conduct was not malicious, and the substantial award of fees already awarded would be of little deterrent value.  Thus an award of punitive damages was not granted.

(d)     Comment

This case highlights the risks a solo petitioner faces in filing an involuntary petition.  While the Bankruptcy Code expressly provides for the joinder of creditors,[1] courts have overridden the provision when the petitioner has failed to engage in a reasonable prefiling inquiry or manifested bad faith.[1] The three creditor requirement is designed to prevent use of involuntary bankruptcy proceedings as a means to obtain pre­ferential payments by litigious creditors or harassing an honest debtor.[1]

The number of the debtor’s creditors is determined at the date the petition is filed, not the date of the hearing.[1] When a solo petitioner files alleging the debtor has less than twelve creditors, employees, insiders and holders of void­able transfers are excluded.[1]

While the K.P. Enterprise court did not directly address the nature of the claims asserted against the debtor, courts have wrestled with the issue of whether or not to include small, recurring debts such as utility bills and credit card bills to determine whether the debtor has twelve or more creditors.  One line of authority excludes small, recurring claims as such creditors interests are not closely tied to the debtor.[1] The policy for excluding these claims is that they are paid off regularly upon the debtor’s receipt of their bills and if the debtor fails to pay for one month, the creditor simply refuses to deal with the debtor the next month.  The contrary authority includes small, recurring creditors when measuring the number of creditors needed to join an involuntary petition because the Bankruptcy Code does not provide for their exclusion.[1]

It should be noted that the petitioner in K.P. Enterprise, upon finding that the debtor had more than twelve creditors, triggering the three petitioner requirement, could not simply withdraw, nor refuse to prosecute, the involuntary petition to avoid section 303(i) costs and damages.[1] Rather, a noticed hearing to all creditors is necessary for a dismissal,[1] and only where there is consent by all petitioners and the debtor to dismissal is a petitioner insulated from a section 303(i) damage claim.[1]

In re Broadview Lumber Co., Inc., 135 B.R. 775 (Bankr. W.D. Mo. 1992).

(a)     Issue Presented

Whether there are at least three qualifying petitioners which hold claims that are not contingent as to the liability or the subject of a bona fide dispute.

(b)     Basic Facts

Debtor elected to liquidate its business pursuant to state law.  Each of its creditors received a check repre­senting 16.6 percent of the amount owed.  Each check included a notice that stated that negotiation of the check constituted a full release of the debtor.  Two petitioners returned their checks uncashed.  A third petitioning creditor cashed the check but added the restrictive endorsement, “Deposited under protest with recourse.”

(c)     Court’s Analysis

Section 303(b)(2) provides that when a debtor has more than twelve creditors, at least three eligible creditors must join in the filing.  Where there are less than three creditors, dismissal is appropriate.  Section 303(b)(1) provides that a petitioning creditor’s claim cannot be contingent as to liability or the subject of a bona fide dispute.  A bona fide dispute must exist as to the validity of the entire claim, and not merely a portion.  The court found that according to principles enunciated in state law, the petitioning creditor reserved its rights to assert a claim with respect to that portion of the debt for which it did not receive payment.  The restrictive endorse­ment barred the debtor’s claim of accord and satisfaction.

(d)     Comment

The court correctly states the rule that when a debtor disputes not the existence of the claim, but merely the amount, that portion of the debt not subject to dispute should be counted.[1]

Professional Accountants’ Referral Services, Inc., 142 B.R. 424 Bankr. D. Col. 1992)

(a)     Issue Presented

Whether a court may appoint a trustee in an involuntary chapter 11 prior to the entry of an order for relief.

(b)     Basic Facts

Creditors accused debtor of dissi­pating assets and fraudulent transfers.  The debtor maintained minimal books and records and allegedly fabricated its financial statements.  The owner of the debtor transferred the assets of the debtor to another corporation under his control.  The creditors filed an involuntary petition for relief under chapter 11 and concurrently filed an emergency motion for appointment of a trustee.

(c)     Court’s Analysis

Section 1104(a)(1) permits the appointment of a trustee where there has been dishonesty or gross mismanagement.  Evidence revealed that the debtor’s financial statements were misleading and that the owner of the debtor was engaged in questionable bookkeeping practices.  Section 105 permitted the court to exercise its equitable powers to administer the case.  Section 303(g), by analogy, provided for the appointment of a chapter 11 trustee.  Denial of a trustee would have had disastrous effects.  The court based its holding that a trustee could be appointed prior to the entry for an order for relief on the fact that it was rather certain that the debtor would be a proper involuntary debtor.  There was a showing the debtor was not paying his debts as they came due.  Without such a finding, appointment of a trustee would be an abuse of discretion.

(d)     Comments

In the context of a chapter 7 pro­ceeding, the Bankruptcy Code expressly provides for the appointment of an interim trustee.[1] The burden is on moving party to establish that appointment of an interim trustee is necessary to preserve property of the estate or prevent loss to the estate.  The decision to appoint a trustee may mean the death of the debtor and thus appointment should be approached cautiously.[1]

There is no comparable provision under chapter 11.  The Professional Accountants’ court refused to follow the holding in Matter of Beaucrest Realty Assoc., 4 B.R. 164 (Bankr. E.D.N.Y. 1980) which rejected the requesting petitioners’ request for an interim appointment of a chapter 11 trustee.  The Beaucrest court restricted its analysis to the statute:

“The absence of a statutory provision for the appointment of an interim trustee in an involuntary Chapter 11 case was not a mere congressional over­sight but rather a deliberate omission.

The only statutory provision with respect to the appointment of an interim trustee in an involuntary case is ‘ 303(g) which pertains exclusively to involuntary Chapter 7 pro­ceedings. … Section 701 governs the appointment of interim trustees under Chapter 7. Clearly the fact that Congress made two specific references to Chapter 7 supports the conclusion that ‘ 303(g) does not authorize a Chapter 11 interim trustee as well as the conclusion that Congress was aware of the fact that it omitted any reference to Chapter 11.  There is no analogous pro­vision under Chapter 11 to that contained in ‘ 701.  An entire statutory scheme provided under Chapter 7 is conspicuously absent under Chapter 11.  Therefore, to infer such a provision as do the petitioners is to do violence to sound statutory construction.”

Beaucrest Realty at 165.

The focus of the Professional Accountants’ court was not the plain meaning of the statute but instead the consequences creditors would face if a trustee was not appointed.  The Professional Accountants’ holding is subject to future challenge in light of the court to defer to the statute’s plain meaning.  Shumate, supra.

In re Petro Fill, Inc., 144 B.R. 26 (Bankr. W.D.Penn. 1992).

(a)     Issues Presented

Whether the debtor is generally not paying its debts as they become due.

(b)     Basic Facts

The debtor sold 49% of its business.  Relations between the debtor and its new owner deteriorated.  The new owner moved out of state to manage the debtor’s operations located there, while the debtor continued its operations.  The debtor failed to pay certain of the debts owing to the new owner.  The new owners com­menced an involuntary chapter 7 petition.

(c)     Court’s Analysis

The determination of whether a debtor is generally not paying its debts involves considera­tion of the totality of the cir­cumstances and balancing of the interests of the debtor and creditors.  A showing that the debtor has unpaid bills may be insuf­fi­cient.  Rather, the court must also inquire whether the petitioning creditor can obtain adequate relief in state court.  The court found the debtor generally paying its undis­puted debts as they came due.  Those debts associated with the shareholder dispute remained unpaid.  Further, in balancing the creditors’ interests, the court found that the creditors would better be served by dismissal of the petition as the involuntary petition sought relief under chapter 7 and the creditors would fare better outside of bankruptcy.  Moreover, the petitioners had adequate remedies outside of bankruptcy, since they could pursue an involuntary dissolution of the debtor under state law.  The mere fact that the petitioners felt it would be more cost effective to liquidate under the Bankruptcy Code is not significant.

(d)     Comments

Congress did not define the “generally not paying” test, but instead deferred to the courts.[1] The test is not to be applied mechanically,[1] and is not a matter of simple mathematics of paid debts to unpaid liabilities.[1] Rather, courts employ a series of factors, the most common of which are: (1) timeliness of payments of past-due obligations; (2) amount of debts long over-due; (3) length of time during which the debtor has been unable to meet large debts; (4) reduction in the debtor’s assets; and (5) debtor’s deficit financial situation.[1]

With the adoption of BAFJA, the “generally not paying” standard excludes those debts that are the subject of a bona fide dispute or contingent.[1] The burden of establishing the standard is on the petitioning creditor.[1] The measuring point for the standard is the date the involuntary petition is filed.[1] The debtor is not excused from its failure to pay a debt merely because a creditor has failed to make demand.[1]

The Petro Fill court found that debtor was paying all debts except those that were the subject of a shareholder dispute.  Id. at 29.  Application of any general failure standard to pay test would not be met based on these facts.

The petitioner’s admission that they could accomplish the same result in state court as in bankruptcy court, Petro Fill at 31, triggers the general rule that if a creditor can obtain an adequate remedy in another court, the bankruptcy court will refuse relief.[1]

In re KZK Livestock, Inc., 147 B.R. 452 (Bankr. C.D.Ill. 1992).

(a)     Issue Presented

Whether the debtor is a family farmer so as to exempt it from an involuntary petition.

(b)     Basic Facts

An individual farmer incorporated and continued its farming operations.  Within a year of incorporation, the bank com­menced an involuntary petition against the corporation.  The debtor contended that as a farmer or family farmer, it is not subject to an involuntary proceeding.

(c)     Court’s Analysis

Section 303(a) exempts a farmer or a family farmer from an involuntary petition.  A farmer is one who receives more than 80% of his gross income during the preceding year from a farming operation.[1] The evidence revealed that there is a triable issue of fact as to whether the debtor met the 80% test.  The bank’s summary judgment motion was denied.

(d)     Comment

Involuntary petitions cannot be brought under chapters 9, 12 or 13.[1] An involuntary petition may only be brought against an entity which meets the criteria provided in section 109.  The Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986, provided for the family farmer exclusion with the addition of chapter 12 to the Bankruptcy Code.  Notwithstanding the adoption of a chapter 12, an involuntary chapter 7 or 11 may be filed against a farmer, as here, with the alleged debtor asserting as a defense that it is a family farm.

In re Accident Claims Determination Corp., 146 B.R. 64 (Bankr. E.D.N.Y. 1992)

(a)     Issues Presented

(1)     Whether failure to timely serve summons warranted dismissal where debtor untimely filed responsive pleading; (2) whether the court should abstain from the involuntary petition.

(b)     Basic Facts

Creditors filed an involuntary chapter 7 petition.  The petitioners were unable to effect service within the time required by the summons.  Notwithstanding the defective service, the debtor requested an extension to respond to the petition after the time to file a responsive pleading had lapsed.  The petitioners refused, and moved for an order for relief.  The bankruptcy court granted the order for relief and the debtor moved to have the order vacated.

(c)     Court’s Analysis

Bankruptcy Rule 1010 requires the Clerk of the Court to issue a summons for service on the debtor.  Service of the summons and a copy of the petition must be served on the debtor within 10 days following the issuance of the summons.[1] A new summons must be issued and served if service is not effectuated within 10 days.[1] A responsive pleading must be filed within 20 days after the service of the summons.[1] If no responsive pleading is filed within the 20 day period, the court shall immediately enter an order for relief.  As both the petitioners and the debtor failed to comply with the bankruptcy rules, the court enter­tained the debtor’s answer.

Prior to the commencement of the involuntary petition, the debtor had filed a complaint in the state court against a corporation to which the petitioners are related or were working for.  Section 305(a) pro­vides that a bankruptcy court may abstain and dismiss an involuntary petition if it is in the interest of the debtor and its creditors.  When adequate remedies lie in state court, the bankruptcy court is not the appropriate forum.  Further, involuntary bankruptcy should not serve as a substitute for state collection remedies.

In accordance with section 305 ample grounds existed to dismiss the petition, and as Bankruptcy Rule 7004 was not complied with, the order for relief was vacated.

(d)     Comment

A bankruptcy court may abstain and dismiss an involuntary petition if it is in the interest of the debtor and its creditors.[1] Abstention is not appeal­able.[1] Grounds for dismissal under section 305 may be found where state court remedies promote a more efficient means of administering the debtor’s assets.[1]

In re Reveley, 148 B.R. 398 (Bankr. S.D.N.Y. 1992)

(a)     Issues Presented

(1)     Whether petitioners con­ducted reasonable investi­gation such that the involuntary petitions were not filed in bad faith; (2) whether petitioners manifested improper motives in filing involuntary petitions.

(b)     Basic Facts

Creditors entered into workout negotiations with four general partners (“Alleged Debtors”) for the repayment of a series of loans and guarantees provided for real estate developments throughout the country.  One of the creditors commenced a state court action against the Alleged Debtors to collect on its guarantees.  The Alleged Debtors filed affirmative defenses and counter claims to the state court action.

During the workout negotiations, creditors learned that the Alleged Debtors had understated their liabilities with respect to their guarantees; that the partnership had underestimated its liabilities; that two of the Alleged Debtors had removed the collateral of a creditor and that the Alleged Debtors failed to provide updated financial information.

Another one of the creditors involved in the workout commenced a state court action against the Alleged Debtors and partnership.  Further workout negotia­tions broke down.  Three petitioners filed involuntary petitions against the Alleged Debtors.  The Alleged Debtors moved to dismiss, asserting the debts were subject to bona fide disputes.  The bankruptcy court tried the claim of one petitioning creditor and found it subject to dispute.  No additional creditors joined and the case was dismissed.  The Alleged Debtors claimed damages of $160 million under section 303(i).

(c)     Court’s Analysis

After a survey of the various bad faith tests, the court found that under any of the tests, the petitioners did not manifest bad faith.  The motivations for filing were to prevent further dissipation of assets and to obtain reliable financial information.  The court rejected the argument that the petitions were designed to coerce the Alleged Debtors to pay a disputed debt.  Further, the Alleged Debtors failed to establish that the petitioners filed based on a strategy to “file/settle/withdraw” to obtain payment on their debts.

With respect to the adequacy of investigation as to whether there existed a bona fide dispute, the court found that petitioners’ counsel conducted an adequate investigation.  Petitioners’ counsel analyzed the merit of the defenses raised by the alleged debtors in the state court actions.  Also, the fact of presigning the verification by an officer of the petitioning creditor was not bad faith.

[1] In Re Ross, 63 B.R. 951, 961 (Bankr. S.D.N.Y. 1986) (involuntary bankruptcy can be viewed as the ultimate prejudgment attachment since it freezes the debtor’s assets for the benefit of all creditors.”)

[1] 11 U.S.C. ‘ 303(a) excludes chapters 9, 12, and 13 involuntary proceedings.

[1] 11 U.S.C. ” 544(b) and 548 permit the trustee to reach back one year (state analogue may provide substantially longer reachback period; see e.g., Calif. Civ. Code 3439.09, four year reachback) from the date of the involuntary filing to invalidate transfers where the insolvent debtor did not receive equivalent value.

[1] 11 U.S.C. ‘ 547 permits the trustee to avoid certain transfers preferring creditors within 90 days (one year for insiders) from the commencement of the involuntary petition.

[1] See e.g., Bankruptcy Rule 1007 et. seq., and the Office of United States Trustee Guidelines. See also In re Reveley, 148 B.R. 398, 409 (petition filed in part to obtain reliable financial information).

[1] 11 U.S.C. ‘ 507 provides that gap claimants, those creditors providing goods and services after the commencement of the involuntary petition and prior to an order for relief, are granted priority over prepetition unsecured creditors.

[1] If the debtor contested an involuntary petition under the Bankruptcy Act, petitioners were required to establish that the debtor had committed an act of bankruptcy. Section 3a of the Act enumerated six such acts: (1) fraudulent transfer, (2) preferential transfer, (3) failure to vacate lien, (4) assignment for benefit of creditors, (5) appointment of state court receiver, (6) written admission of inability to pay debts. The practical effect of establishing an act of bankruptcy was proving the debtor’s insolvency. 2 Collier on Bankruptcy & 303.12 (15th ed. 1991).

[1] The general failure to pay standard adopted by the Bankruptcy Code measures an external event, the debtor’s default on obligations. Conversely, the Bankruptcy Act’s de facto solvency standard measured an internal event, the debtor’s capital structure. Congress believed it easier for a creditor to obtain information to prove an external event. Block-Lieb, Why Creditors File So Few Involuntary Petitions And Why The Number Is Not Too Small, 57 Brooklyn L.R. 803, 811-12 (1992) (hereafter “Involuntary Petitions”).

[1] In re B.D. Int’l Discount Corp., 15 B.R. 755, 762 (Bankr. S.D.N.Y. 1981) aff’d, 24 B.R. 876 (S.D.N.Y. 1982), aff’d 701 F.2d. 1071 (2nd Cir.), cert. denied 464 U.S. 830 (1983).

[1] 28 U.S.C. ‘ 1411(b) and Bankruptcy Rule 9015; In re Drexler, 39 B.R. 18 (Bankr. S.D.N.Y. 1984.)

[1] Bankruptcy Rule 1013.

[1] In re Leach, 92 B.R. 483, 487 (Bankr. D. Kan. 1989).

[1] 11 U.S.C. ‘ 303(b)(1).

[1] 11 U.S.C. ‘ 303(h)(1). With the adoption of the Bankruptcy Amendments and Federal Judgeship Act of 1984 (“BAFJA”), Congress excluded those debts subject to a bona fide dispute from the calculus of whether the debtor was generally not paying its debts.

[1] 11 U.S.C. ‘ 303(b)(1). BAFJA intro­duced the requirement that a petitioner’s claim not be contingent or the subject of a bona fide dispute.

[1] 11 U.S.C. ‘ 303 (b)(1).

[1] 11 U.S.C. ‘ 303(e); LNC Investments, Inc. v. Secured Equipment Trust of Eastern Airlines, Inc. (In re Secured Equipment Trust of Eastern Air Lines, Inc.), 148 B.R. 398 (Bankr. S.D.N.Y. 1992).

[1] 11 U.S.C. ‘ 303(i).

[1] Block-Lieb, Involuntary Petitions, 837-39.

[1] An argument can be made that a petitioning creditor can rely on the verification signed by a joining petitioning creditor that such joining creditor has conducted a reasonable investigation as to whether it has standing. See Bankruptcy Rule 1008; In re Reveley, supra at 411. But see Bankruptcy Rule 7027 pertaining to depositions before an adversary action or pending appeal may be applicable to involuntary proceedings. 2 Collier on Bankruptcy & 303.30 (15th ed. 1991).

[1] 11 U.S.C. ‘ 303(h) necessitates a trial if the petition is contested.

[1] A petitioning creditor has the burden to establish a prima facie case that no bona fide dispute exists. Once established, the burden shifts to the debtor. Mark Twain Bank v. Rimell (In re Rimell), 946 F.2d 1363, 1365 (8th Cir. 1991) cert. denied, ___ U.S. ___ (1992). Where the debtor has twelve or more creditors, three creditors must join in the petition. All of the petitioners must carry their burden. If one petitioner fails, the petition is dismissed unless a substitute petitioner joins. LaRoche v. Amoskeag Bank (In re LaRoche), 969 F.2d 1299 (1st Cir. 1992).

[1] A petitioning creditor has the burden of proof as to whether the debtor is generally paying its nondisputed debts. Bartman v. Maverick Tube Corp., 853 F.2d 1540, 1546 (10th Cir. 1988).

[1] There is a presumption of good faith in favor of petitioning creditor. The debtor has the burden of showing bad faith. United States Fidelity & Guaranty

Co. v. DJF Realty & Suppliers, 58 B.R. 1028, 1011 (N.D.N.Y. 1986).

[1] 11 U.S.C. at 305. Abstention, however, is an extraordinary remedy. In re Ceiling Fan Distributor,Inc., 37 B.R. 701, 703 (Bankr. M.D. La. 1983).

[1] 11 U.S.C. ‘ 305; In re Accident Claims Determination Corp., 146 B.R. 64 (Bankr. E.D.N.Y. 1992).

[1] In re Central Hobron Assoc., 41 B.R. 444, 451 (Bankr. D.Hawaii 1984); In re Kass, 114 B.R. 308, 309 (Bankr. S.D.Fla. 1990); In re Blaine Richards, 16 B.R. 362, 364 (Bankr. E.D.N.Y. 1982) (where debt disputed, court scrutinizes whether creditor needs relief in the bankruptcy court).

[1] See e.g. In re Reveley, supra (debtors sought damages of $160,000,000 after petitioner’s debt found subject to a bona fide dispute warranting dismissal of petitions); In re Secured Equipment

Trust of Eastern Air Lines, Inc., 1992 WL 295943 (S.D.N.Y.) (debtor asserted damages of $133,333 per day from the date of the filing).

[1] 11 U.S.C. ‘ 303(i)(1).

[1] 11 U.S.C. ‘ 303(i)(2).

[1] BAFJA also inserted the requirement that a debt subject to a bona fide dispute not be included in the determination as to whether the debtor was paying its debts as they came due. 11 U.S.C. ‘ 303(h)(1).

[1] In re Lough, 57 B.R. 993, 997 (Bankr. D.Mich. 1986).

[1] S. 7618, 98th Cong. 2d Sess., June 1984.

[1] In re Reveley, supra at 400.

[1] 11 U.S.C. ‘ 303(c).

[1] In re Rimell, supra at 1365 (8th Cir. 1991); B.D.W. Associates, Inc. v. Busy Beaver Building Centers, Inc. (In re B.D.W. Associates, Inc.), 865 F.2d 65, 66-67 (3rd Cir. 1989); Bartman v. Maverick Tube Corp., supra; In re Busick, 831 F.2d 745, 750 (7th Cir. 1987); (the court adopted the test with a gloss: “substantial” factual and legal questions raised by debtor preclude finding of involuntary bankruptcy). The origin of this test is In re Lough, supra.

[1] In re Busick, supra at 749.

[1] In re Rimmell, supra at 1365.

[1] In the Matter of Boswick, 65 B.R. 630, 637 (N.D.Ind. 1986).

[1] In re Busick, supra at 750.

[1] In re Johnston Hawks, Ltd., 49 B.R. 823, 831 (Bankr. D.Hawaii 1985).

[1] In re Ross, supra at 960.

[1] In re Lough, supra at 997.

[1] In re Stroop, 51 B.R. 210, 212 (D.C.D.Col. 1985)

[1] In re Tikijian, 78 B.R. 304, 315 (Bankr. S.D.N.Y. 1987); In re Lough, supra at 997.

[1] In re Petralex Stainless, Ltd., 78 B.R. 738, 744 (Bankr. E.D.Pa. 1987) (“even if a bona fide dispute did exist, we would have discretionary power to allow the joinder of additional creditors to ‘cure’ the defective filing.”); In re Elsub Corp., 70 B.R. 797 (Bankr. D.N.J. 1987); 11 U.S.C. ‘ 303(c), Bankruptcy Rule 1003(b).

[1] In re CLE Corp., 59 B.R. 579, 584 (Bankr. N.D. Ga. 1986); United States Fidelity & Guaranty Co. v. DJF Realty & Suppliers, supra (bankruptcy court’s finding of bad faith based on the petitioner’s solicitation of another to join in petition held in error).

[1] Basin Elec. Power Co-op v. Midwest Processing Co., 769 F.2d 483, 486 (9th Cir. 1985) cert. denied, 106 S.Ct. (1986) (“[a]n essential prerequisite for allowing joinder of additional creditors to cure a defective petition is that the petition was filed in good faith. (Citations omitted)”). See notes 78 through 82 infra surveying various bad faith tests.

[1] In re LaRoche, 131 B.R. 253, 259 (D.R.I. 1991).

[1] Bankruptcy Rules 1018, 2004 and 7020-7037 apply to involuntary cases.

[1] 11 U.S.C. ” 541, 522.

[1] 11 U.S.C. ‘ 541.

[1] 11 U.S.C. ‘ 524.

[1] 11 U.S.C. ‘ 704. Block-Lieb Involuntary Petitions, 846-47.

[1] In re Garland Coal & Mining Co., 67 B.R. 514 (Bankr. W.D. Ark. 1986) (creditors paid in full before the filing date had no standing to join petition).

[1] Claim is defined in 11 U.S.C. ‘ 101(4) as:

(A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, dis­puted, undisputed, legal, equitable, secured, or unsecured; or

(B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.

[1] In re Ross, supra at 961.

[1] In re Nordbrock, 772 F.2d 397, 399 (8th Cir. 1985).

[1] In re Beacon Reef Ltd. Partnership, 43 B.R. 644, 647 (Bankr. S.D. Fla. 1984).

[1] In the Matter of Ramsden, 17 B.R. 59 (Bankr. N.D.Ga. 1981).

[1] In re Reid, 854 F.2d 156 (7th Cir. 1988).

[1] In re Advance Press & Litho, Inc., 46 B.R. 700,702 (D.Colo. 1984).

[1] re K.P. Enterprise, 135 B.R. 174, 177 (Bankr. D.Me. 1992); In re Ross, supra at 237 (award should be routine unless dismissal follows a seizure of the debtor’s property or a finding of bad faith, wherein the standard is even more favorable to the debtor); In re Leach, supra at 808 (award of costs and fees routine); In re Anderson, 95 B.R. 703, 705 (Bankr. W.D.Mo. 1989) (denial of costs and fees may be appropriate only in limited circumstances).

[1] In re Reid, supra at 160; see also, In re Ross, supra at 238 (totality of circumstances considered before award granted).

[1] In re West Side Community Hospital, Inc., 112 B.R. 243, 258 (Bank. N.D.I. 1990). In re Fox Island Square Partner­ship, 106 B.R. 962, 966 (Bankr. N.D.Ill. 1989).

[1] In re Ross, supra at 236 (“[i]f attorney’s fees were limited to bad faith filings, then the fee provision would be found not in subsection 303(i)(1) but in subsection 303(i)(2).”); In re Advance Press & Litho, Inc., supra at 702 (given the disjunctive provisions of subsections 303(i)(1) and (2), Congress envisioned situations where even with dismissal of good faith filings, petitioners should pay for the burden they created). Given the Supreme Court’s inclination for strict statutory construction, see e.g. Patterson v. Shumate, 112 S.Ct. 2242, 2246 (1992), Union Bank v. Wolas (In re ZZZZ Best Co., Inc.), 112 S.Ct. 527, 531 (1991) and Toibb v. Radloff, 111 S.Ct. 2197, 2198 (1991), costs and attorney’s fees without a finding of bad faith is appropriate.

[1] In re Wavelength, 61 B.R. 614, 621 (9th Cir. BAP 1986).

[1] Express standard for the award of fees under the Bankruptcy Code.

[1] In re K.P. Enterprise, supra at 178; In re Better Care, Ltd., 97 B.R. 405, 413 (Bankr. N.D.Ill. 1989) (section 330 requires attorney’s fees be based upon actual and necessary legal services, while section 303 merely requires fees be reasonable). Cf. In re Ross, supra at 239 (lodestar analysis applied to determine the reasonableness of attorney’s fees).

[1] In re K.P. Enterprise, supra at 178. Other costs, in the form of damages, is addressed in section 303(i)(2).

[1] In re Ross, supra at 239; In re Advance Press & Litho, Inc., supra at 702. (where particular petitioner driving force behind petition, the bulk of award may be awarded against that petitioner); 2 Collier on Bankruptcy & 303.39 (15th ed. 1991) (Congress intends to confer liability only on the bad faith petitioner as the statute states “any petitioner” and not “all” petitioners).

[1] In re Better Care, Ltd., supra at 415 (setoff allowed). But see In re K.P. Enterprise, supra at 185B86 (no mutuality of obligations, no setoff); In re Schiliro, 72 B.R. 147 (Bankr. E.D.Pa. 1987) (no mutuality, no setoff).

[1] In re International Mobile Adver­tising Corp., 117 B.R. 154, 158 (Bankr. E.D.Pa. 1990); In re Ramsden, supra at 61 (“When a judgment is entered against creditors whose actions were predicated upon legal advice, the creditors’ remedy is else­where to be resolved.”); but see, In re Turner, supra at 628 (liability of counsel addressed under Rule 9011 in absence of separate motion).

[1] In re International Mobile Advertising Corp., supra at 158.

[1] In re Turner, 80 B.R. 618, 622 (Bankr. D. Mass. 1987).

[1] In re Laclede Cab Co., 76 B.R. 687, 693 (Bankr. E.D.Mo. 1987).

[1] In re Broshear, 122 B.R. 705, 708 (Bankr. S.D. Ohio 1991); In re Caucus Distributors, Inc., 106 B.R. 890, 898 (Bankr. E.D. Va. 1989).

[1] See e.g., In re Midwest Processing Co., 41 B.R. 90, 102 (Bankr. D.N.D. 1984); In re Grecian Heights Owners’ Assoc., 27 B.R. 172, 173 (Bankr. D.Or. 1982).

[1] See e.g., In re Fox Island Square Partnership, supra at 967; Basin Elec. Co-Op. v. Midwest Processing Co., supra.

[1] In re Salmon, 128 B.R. 313, 315 (Bankr. M.D.Fla. 1991) (motive to destroy debtor); In re Better Case, Ltd., supra at 411 (petitioner motivated by ill-will to shut down business); In re Laclede Cab Co., supra at 693 (petition filed to force debtor into labor negotiations). Cf. In re Secured Equipment Trust of Eastern Air Lines, Inc., supra (petition filed to gain settlement leverage improper; petition filed to resolve intercreditor disputes through a plan of reorganization proper).

[1] In re Nordbrock, supra at 399 (bankruptcy proceeding used as a substitute for customary collection proceedings); In re Wave­length, supra at 622 (attempt to take over corporation). Cf. In re Reveley, supra at 409 (not an improper use where petitions filed to prevent loss of assets, obtain financial information and institute an orderly workout of creditors’ claims); In re West Side Community Hosp., Inc., supra at 259 (petition filed to liquidate debtor in an orderly fashion without preference to creditors not an improper use).

[1] See e.g., In re Reveley, supra at 407; In re Secured Equipment Trust of Eastern Air Lines, Inc., supra; Landon v. Hunt, supra at 833; In re K.P. Enter­prise, supra at 180; In re Fox Island Square Partnership, supra at 967; In re Better Case, Ltd., supra at 409; In re West Side Community Hospital, supra at 258; In re Turner, supra at 622-23 (application of Rule 9011 standard is consistent with judicially created standard for dismissal of a voluntary petition under 11 U.S.C. ‘ 1112); In re Petralex Stainless Ltd., supra 743.

[1] In re Alta Title Co., 55 B.R. 133, 141 (Bankr. D. Utah 1985).

[1] In re CLE Corp., supra at 583.

[1] In re Reveley, supra at 406.

[1] It is clear that the bankruptcy court was never meant to serve as an insurance policy for creditors who fear that the state courts will not give them what they want. In re R.N. Salem Corp., 29 B.R. 424, 429 (S.D. Ohio W.D. 1983).

[1] “Damages may include such items as loss of business during and after the pendency of the case and so on.” H.R. Rep. No. 595, 95th Cong., 1st Sess. 324 (1977), U.S. Code Cong. & Admin. News 1978 pp. 5787, 6280.

[1] The two purposes of punitive damages in the context of involuntary proceedings are punishment and deterrence. In re Laclede Cab Co., supra at 694. How­ever, as the only damage suffered in an involuntary petition generally is financial, as opposed to damage to life and health of the public, punitive damages should be restricted.

In re Better Care, Ltd., supra at 414. While the threat of punitive damages may have leverage with petitioners contemplating whether to commence an involuntary petition, the actual awards have been limited in number and amount. See e.g., Landon v. Hunt, supra at 832 ($12,000 award); In re Laclede Cab Co., supra at 694 ($15,000 award); cf. In re K.P. Enterprise, supra at 184 (denial of punitive damages as substantial award of fees, costs and compensatory damages serves policy to deter).

[1] In re Paradise Hotel Corp., 842 F.2d 47 (3rd Cir. 1988); In re Salmon, supra (debtor may pursue malicious prosecution claim against petitioners).

[1] In re Wavelength, supra at 621-22; but see, In re Laclede Cab Co., supra at 693B694 (debtor denied actual damages where it failed to prove proximate causation).

[1] 2 Collier on Bankruptcy & 303-39 (15th Ed. 1991).

[1] In re Ross, supra at 234.

[1] In re Contemporary Mission, Inc., 30 B.R. 369 (Bankr. D. Conn. 1983).

[1] Section 303(i), Bankruptcy Rule 1011(d) and (e).

[1] In re Sweet Transfer & Storage, Inc., 896 F.2d 1189, 1191 (9th Cir. 1990).

[1] In re Ross, supra at 234; Paradise Hotel Corp. v. Bank of Nova Scotia, supra.

[1] Bankruptcy Rule 1003(b) provides that:

“If the answer to an involuntary petition filed by fewer than three creditors avers the existence of 12 or more creditors, the debtor shall file with the answer a list of all creditors with their addresses, a brief statement of the nature of their claims, and the amounts thereof. If it appears that there are 12 or more creditors as provided in ‘ 303(b) of the Code, the court shall look for a reasonable opportunity for other creditors to join in the petition before a hearing is held thereon.” (Emphasis supplied.)

[1] In re Caucus Distributors, Inc., supra; In re Goodroy Wholesale Co., 37 B.R. 496, 500 (Bankr. D. Mass. 1984) (bad faith where petitioner failed to make additional inquiries which were not unreasonable); In re American President Lines, Ltd., 804 F.2d 1307 (D.C. Cir. 1986) (frivolous filing where debtor corporation was of such size and complexity that a reasonable person would have probably known it had more than twelve creditors). In re Earl’s Tire Service, 6 B.R. 1019 (D. Del. 1980) (Where the solo petitioner files in an attempt to confer jurisdiction on the court and additional creditors will join.); see also In re Eberhart Moving & Storage, Ltd., 120 B.R. 121, 122 (Bankr. D.N.D. 1990) (bad faith is present when a solo creditor knew or should have known that debtor had twelve or more creditors); But see In re J.V. Knitting Services, Inc., 4 B.R. 597, 598 (Bankr. S.D. Fla 1980) (fraud of petitioning

creditor does not bar joinder of additional creditors).

[1] In re Skye Marketing Corp., 11 B.R. 891, 897 (Bankr. E.D.N.Y. 1981).

[1] In re Nina Merchandise Corp., 5 B.R.173 (Bankr. S.D.N.Y. 1980); In re Garland Coal & Mining Co., 67 B.R. 514 (Bankr. W.D. Ark. 1986).

[1] 11 U.S.C. ‘ 303(b)(2).

[1] Sipple v. Atwood (In re Atwood), 124 B.R. 402, 405 (Bankr. S.D. Ga. 1991); In re Smith, 123 B.R. 423, 425 (Bankr. M.D. Fla 1990); In re Blaine, Richards & Co., 10 B.R. 424 (Bankr. E.D.N.Y. 1981) (de minimis debt would not be considered in determining the number of creditors needed to join petition, as large creditors are entitled to access the bankruptcy courts and should not be blocked by the deliberate creation of a variety of small claims whose holders have no realistic interest in the debtor).

[1] Jefferson Trust & Savings Bank of Peoria v. Rassi (In re Rassi), 701 F.2d 627, 632 (7th Cir. 1983) (“regardless of how wise and salutary the exclusion of small, recurring claims might be, Congress has not specifically authorized exclusion, and in the absence of any indication that Congress intended this exclusion, we have no authority to engraft it on to those that Congress expressly provided.”) In light of the

Supreme Court’s strict statutory con­struction, see infra, the better view is to include small, recurring claims in determining the number of creditors necessary to commence an involuntary petition.

[1] 11 U.S.C. ‘ 303(j).

[1] 11 U.S.C. ‘ 303(j); Bankruptcy Rule 1019.

[1] 11 U.S.C. ‘ 303(i).

[1] In re Covey, 650 F.2d 877, 883 (7th Cir. 1981); In re Galaxy Boat Mfg. Co., Inc., 72 B.R. 202B03 (D.C.S.C. 1986); In re Drexler, supra. Where the amount not subject to dispute is less than $5,000 and it is a solo petition, the petitioner will need the joinder of a creditor with an undisputed claim that, collectively, total $5,000.

[1] 11 U.S.C. ” 303(g), 701;

Bankruptcy Rule 2001.

[1] 2 Collier on Bankruptcy, & 303.35 (15th Ed. 1991); In re Rush, 4 C.B.C. 2d 427 (Bankr. N.D.Ala. 1980) (“The dis­ruption of the financial life of the debtor by the appointment of an interim trustee could well leave the financial life of the debtor scarred and crippled beyond any real chance for recovery, although the debtor victorious in resisting the involuntary petition.”)

[1] In re CLE Corp., supra at 585.

[1] In re B.D. International Discount Corp., supra at 1076.

[1] In re CLE Corp., supra at 579.

[1] In the Matter of Bishop, Baldwin, Rewald, Dillingham & Wong, Inc., 779 F.2d 471 (9th Cir. 1985); In re Gill Enterprises, Inc., 15 B.R. 329 (D.N.J. 1981).

[1] “Claims are contingent as to liability if the debt is one which the debtor will be called upon to pay only upon the occurrence or happening of an extrinsic event which will trigger the liability of the debtor to the alleged creditor and if such triggering event or occurrence was one reasonably contem­plated by the debtor and creditor at the time the event giving rise to the claim occurred. In re All Media Properties, Inc., 5 B.R. 126, 133 (Bankr.S.D. Texas 1980), aff’d. 646 F.2d 193 (5th Cir. 1981).

[1] In re CLE Corp., supra at 585.

[1] In re Bishop, Baldwin, Rewald, Dillingham & Wong, Inc., supra at 475.

[1] In re All Media Properties, supra at 145.

[1] In re Nar-Joc Enters., 6 B.R. 584, 586 (Bankr. S.D.Fla. 1981).

[1] 11 U.S.C. ‘101(18).

[1] 11 U.S.C. ‘303.

[1] Bankruptcy Rule 7004.

[1] Bankruptcy Rule 7004(f).

[1] Bankruptcy Rule 1011(b).

[1] 11 U.S.C. ‘ 305

[1] In re Covey, supra at 879.

[1] See, In re Trina Assocs., 128 B.R. 858 (Bankr. E.D.N.Y. 1991) (best interests served with abstention where parties had reached agreement on state court action); Cassco Machining, Inc. v. Rimpull Corp. (In the Matter of Rimpull Corp.), 26 B.R. 267 (Bankr. W.D. Mo. 1982) (out of court workout approved by creditors); In re Michael S. Starbuck, Inc., 14 B.R. 134 (Bankr. S.D.N.Y. 1981) (state court is competent to resolve management and shareholder disputes).

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