Good Faith Required in Filing an Involuntary Bankruptcy

Involuntary Bankruptcy

In a new ruling, In re Forever Green Athletic Fields, Inc.,__F.3^rd __(3d. Cir. Oct. 16, 2015), the Third Circuit has joined several other courts in holding that an involuntary bankruptcy petition may be dismissed as a bad faith filing, even if the involuntary petitioners have satisfied all of the explicit requirements under §303 of the Bankruptcy Code.

In the case, the petitioners were long-time antagonists of the debtor and of its principal. In Louisiana litigation, two of the petitioners obtained a $300,000 judgment against the debtor. In a Pennsylvania action, however, the debtor sued the petitioners’ company and the petitioners for diversion of corporate assets. This matter proceeded to consensual arbitration, which was pending when the Louisiana action went to judgment. Petitioners admitted in a deposition that they had intended to do whatever they could to get the Louisiana judgment paid. Apparently, they also intended to derail the arbitration.

It was conceded that the petitioners satisfied the statutory requirements for commencing an involuntary bankruptcy, in that they numbered three creditors, with uncontested claims aggregating at least $15,325. Bankruptcy Code §303(b)(1). Moreover, the debtor had essentially shut down its business and was winding down its affairs, thus satisfying the further requirement that the debtor not generally be paying its debts as they became due. Bankruptcy Code §303(h)(1).

The ruling

Nevertheless, the bankruptcy court entered an order dismissing the involuntary petition. The court held that it was a court of equity, and that — as such — a petitioning involuntary creditor, or even a voluntary filing debtor, had to come to court for a proper purpose. The court concluded that one of the petitioners was a bad faith creditor, since he was motivated by two improper purposes: to frustrate the debtor’s efforts to litigate the Pennsylvania action, as well as because of his own efforts to collect on the Louisiana judgment. The bankruptcy court accordingly dismissed the involuntary petition.

The Third Circuit acknowledged that the petitioners satisfied the statutory requirements under Bankruptcy Code §303. It further noted that, aside from the reference in §303, where the court is allowed to award damages when an involuntary petitioner files a petition in bad faith, the statute does not in so many words require good faith in order to file an involuntary petition. Moreover, voluntary petitions are expressly subject to dismissal if filed in bad faith, and the Third Circuit took note of the fact that Congress could easily have placed such an explicit requirement in §303 if it had wanted. Nevertheless, the Third Circuit concluded that Congress did indeed intend that bad faith be a basis not only for the awarding of damages on dismissal under §303 but, moreover, as a basis for dismissal itself.

Why the good faith?

The Third Circuit began with the point that bankruptcy courts are courts of equity, and that good faith filing requirements have “strong roots in equity.” Therefore, bankruptcy courts “are equipped with the doctrine of good faith so that they can patrol the border between good and bad-faith filings.” Indeed, the Third Circuit noted that the majority of courts agree that involuntary bankruptcy petitions may be dismissed for bad faith. For example, In re Bock Transp., Inc., 327 B.R. 378, 381 (B.A.P. 8^th Cir. 2005), and In re U.S. Optical, Inc., 1993 WL 93931 (4^th Cir. Apr. 1, 1993).

Moreover, the Third Circuit looked to the policy considerations under the statute and held that the courts should be wary of creditors who seek to thrust a debtor into bankruptcy for reasons of retribution. The court felt that involuntary filings are justified only when a creditor simply seeks to protect against the preferential treatment of other creditors or the dissipation of the debtor’s assets.

In testing how to evaluate whether an involuntary petition has been filed in bad faith, the Court adopted a “totality of the circumstances” standard, which applies both a subjective and an objective test. The first looks to whether the filing was motivated by ill will, malice, or a desire to harass or embarrass the alleged debtor. The objective test assesses what a reasonable person would have believed and done in the same position. Factors include: whether the petitioners made a reasonable inquiry into the facts and law; whether there was evidence of preferential payments to other creditors or dissipation of assets; whether the filing was motivated by ill will or a desire to harass; and whether the filing was motivated by an attempt to obtain a disproportionate advantage or a tactical advantage in collecting the debt.

Based upon all of this, the court concluded that the petitioners in the instant matter had more than demonstrated their bad faith, and it affirmed the dismissal above.

Are you a creditor in a bankruptcy?  Have you been sued by a bankrupt?  If you have any questions about your rights, please contact me, Joel Glucksman, at 201-806-3364.