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Involuntary Bankruptcy Primer Part I: Understanding the Oft Ignored Involuntary Bankruptcy Petition (with Bankruptcy Cave Embedded Briefs for Your Use!)

August 30, 2016

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Editor’s Note:  This is a new one for us at The Bankruptcy Cave.  We are starting a series of primers, covering a narrow range of law but with more depth than just “here’s a recent case.”  And also, we have our first edition of “The Bankruptcy Cave Embedded Briefs” – top quality briefs on a certain issue, feel free to download to your own form files or come back and grab ’em when you need ’em.  Let us know what you think – we are always trying to improve things around here for our readers.

 

Involuntary bankruptcy is an underused but potentially powerful tool in the Bankruptcy playbook.  Although the process to initiate an involuntary case is relatively straightforward (and has been largely unchanged for decades), the scarcity of involuntary petitions filed each year means few bankruptcy lawyers have any practical experience in this area of law.  In 2012 (the last year for which we have good data) just over 500 involuntary bankruptcy petitions were filed, representing but .04% of total bankruptcy filings.[1]

Initiating the Involuntary Case

An involuntary case is commenced by the filing of an involuntary bankruptcy petition under Chapter 7 or 11 of the Bankruptcy Code.[2]  With a few exceptions,[3] creditors holding “a claim … that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount” have standing to file an involuntary bankruptcy petition.  A bona fide dispute must be to the debt’s existence and validity, and not merely the amount of the debt owed.[4]

An involuntary petition requires three or more creditors with an aggregate claim of at least $15,325.[5]  However, if the putative debtor has fewer than twelve total creditors (excluding employees and insiders), a single creditor may file an involuntary petition if its claim exceeds $15,325.

  • The Bankruptcy Cave Embedded Briefs: Can you have an involuntary case if the Debtor has just one creditor? Yes – so long as there is a “bankruptcy purpose” to the case – fraudulent transfers, the need for a trustee, or other relief that is somewhat unique to the Bankruptcy Code.  Check out this imbedded brief [Imbedded Brief 1] on the issue (which won), and use for future reference.  And see the posts cited below for more on the requirement that there be a “bankruptcy purpose” for an involuntary case, even where the statutory standards are met.

The requirements of Section 303 are determined at the moment the involuntary petition is filed; a putative debtor cannot defeat an involuntary petition by subsequently paying off the petitioning creditors to reduce their number or to generate a “bona fide dispute” as to a claim.[6]  Additionally, Section 303(c) permits other creditors to join a petition after it is filed to cure a deficiency in the original petition.[7]

Unlike a voluntary petition under Chapter 7 or 11, the filing of an involuntary petition does not constitute an order for relief under Section 301(b) and, therefore, most provisions of the Bankruptcy Code do not yet apply.  Until an order for relief is entered, a putative involuntary bankruptcy debtor may continue to operate under normal business conditions, as if the involuntary petition had never been filed.[8]

Challenging the Involuntary Bankruptcy Petition, Part I – The Statutory Standards

Filing an involuntary bankruptcy petition is akin to filing a lawsuit against the putative debtor.  Upon the petition filing, the bankruptcy court clerk will issue a summons to be served on the debtor,[9] and the debtor generally has twenty-one days from the date of service to respond.[10]  If contested, a bench trial on the petition will be held.  The petitioning creditors must prove that the threshold elements of Section 303(b) were met and either:

  1. the debtor is generally not paying its debts as they 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.[11]

The “generally not paying debts” standard looks to the totality of the circumstanced at the time the involuntary petition was filed, and takes into consideration the following, non-exclusive factors: (i) the number and amount of unpaid claims; (ii) the materiality of the nonpayment; (iii) duration of nonpayment; (iv) total amount of indebtedness and financial situation; and (v) any reduction in the debtor’s assets.[12]

If the petitioning creditors can establish that the putative debtor is generally not paying debts, or that a custodian has been appointed over substantially all of the putative debtor’s property, an order for relief will be entered and the case will proceed in the same course as a voluntary Chapter 7 or Chapter 11 case.

Challenging the Involuntary Bankruptcy Petition, Part II – An Independent Requirement of Good Faith?

Recent Delaware caselaw indicated that even an involuntary petition that satisfies the statutory requirements of Section 303 can be dismissed, if there is an ulterior motive to the filing separate from the collection of a debt.  In one case, the petitioners’ primary desire to effectuate a change in management, and not to collect their debts, rendered the filing in bad faith.  Check out the analysis (and a link to the opinion) here, courtesy of John Bird of Fox Rothschild.  In another recent case, the petitioning creditors were using the bankruptcy case to transfer venue of long-running litigation, resulting in another dismissal of the case due to bad faith.  Check out this additional analysis (and a link to the opinion) here, from Ben Keenan of Ashby and Geddes.  (By the way, Fox Rothschild’s Delaware Bankruptcy Litigation blog and Ashby and Geddes’s Delaware Bankruptcy Insider are really the two best Delaware-centric bankruptcy blogs out there – must-read stuff (in addition to The Bankruptcy Cave, of course) to stay abreast of DE happenings and DE’s influence in the restructuring world.)

We hope you liked Part I of this Involuntary tips and traps (with Bankruptcy Cave Embedded Briefs).  Stay tuned for Part II of this post in a few weeks, The Risks and Rewards of the Involuntary Bankruptcy Petition.

[1] See Table 7.2—U.S. Bankruptcy Courts Judicial Facts and Figures (September 30, 2012) at http://www.uscourts.gov/statistics/table/72/judicial-facts-and-figures/2012/09/30

[2] See 11 U.S.C. § 303(b).

[3] See 11 U.S.C. §§ 303(b)(3)-(4).

[4] See In re Busick, 831 F.2d 745, 747 (7th Cir. 1987); Efron v. Gutierrez, 226 B.R. 305, 312 (D. P.R. 1998); In re Food Gallery at Valleybrook, 222 B.R. 480, 487 (Bankr. W.D. Penn. 1998) (a dispute as to the proper interest rate and the method for amortization is not a bona fide dispute of the debt). See also Vortex Fishing, 277 F.3d at 1066-1067 (existence of litigation, or mere filing of answer to a claim, cannot, by itself, constitute a bona fide dispute, but affirmative defenses, including defense that petitioning creditor’s action made debtor’s performances impossible, raised a bona fide dispute to otherwise undisputed debt on open account.) (“So long as the petitioning creditor has established that there is no dispute regarding the debtor’s liability on the creditor’s claim, the creditor has standing.”).  That said, as noted in the Bankruptcy Insider blog post cited below, there remains an open issue as to whether a dispute as to part of a debt is enough to disqualify it for purposes of Section 303, if the undisputed part still is more than the statutory threshold.

[5] As of the time of this article. The dollar threshold for filing an involuntary petition is adjusted for inflation annually.

[6] In re All Media Prop., Inc., 5 B.R. 126, 137 (Bankr. S.D. Tex. 1980); Liberty Tool & Mfg. v. Vortex Fishing Systems, Inc. (In re Vortex Fishing Systems, Inc.), 277 F.3d 1057, 1063 (9th Cir. 2002). See also 11 U.S.C. § 549(b).

[7] See, e.g., Basin Elec. Power Co-op. v. Midwest Processing Co., 769 F.2d 483, 486, 87 (8th Cir. 1985).

[8] 11 U.S.C. § 301(b); 11 U.S.C. § 303(f). However, Section 303(g) permits a party in interest to request the appointment of an interim trustee under Section 701 “if necessary to preserve the property of the estate or to prevent loss to the estate.”

[9] Fed. R. Bankr. P. 1010.

[10] Fed. R. Bankr. P. 1011.

[11] 11 U.S.C. § 303(h).

[12] See Maverick Tube Corp., 853 F.2d at 1546; Vortex Fishing, 277 F.3d at 1064; In re Arriola Energy Corp., 74 B.R. 784, 789 (Bankr. S.D. Tex. 1987); In re Norris, 183 B.R. 437, 455 (Bankr. W.D. La. 1995).  We at The Bankruptcy Cave are also always pleased to find an opinion on point from the great jurist Judge Drake – founder of the SBLI, former president of the NCBJ, and skilled jurist of the highest caliber – see In re Smith, 243 B.R. 169 (Bankr. N.D. Ga. 1999) (debtor was current on day-to-day expenses, but was months past due with large creditors; held that the debtor was not paying its debts as they came due).

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The Un-Bankruptcy: A Texas Receivership as an Alternative to Bankruptcy (and fourteen ways to appoint a receiver in The Lone Star State)

April 11, 2016

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Creditors seeking to exercise control over a borrower or collateral may utilize a number of remedies. They may seek a foreclosure or UCC sale, assignment for the benefit of creditors, file an involuntary bankruptcy petition under Section 303 of the Bankruptcy Code (if they hold unsecured claims),[1] or, seek the appointment of a receiver.

Bankruptcy and receivership provide a particular advantage because they allow creditors to take control of the debtor or collateral without the risk of taking possession.  (See the prior post by my colleagues Jay Krystinik and Keith Aurzada on ways lenders may minimize risk in wresting control of a property away from a obligor, here.)  Receiverships provide the additional benefit of flexibility and, often, are more easily obtained and less costly than an involuntary bankruptcy.[2]  Both federal[3] and state laws provide for the appointment of receivers.

Receivership laws vary from state to state and, indeed, most states provide a veritable cornucopia of receivership statutes.  Here, we will look at the receivership laws in the State of Texas to demonstrate the breadth and scope of state receivership laws.

Availability of Receivership

Texas law provides for the appointment of a receiver in many ways:

  • by a vendor to vacate a fraudulent purchase of property (Texas Business Organizations Code section 11.403(1));
  • by a creditor to subject property or funds to the creditor’s claim (Texas Business Organizations Code section 11.403(2));
  • between partners or others jointly owning or interested in property or funds (Texas Business Organizations Code section 11.403(3));
  • by a mortgagee of the property for the foreclosure of the mortgage and sale of the property (Texas Business Organizations Code section 11.403(4)):
  • for a corporation that is insolvent, is in imminent danger of insolvency, has been dissolved, or has forfeited its corporate rights (Texas Civil Practices and Remedies Code 64.001(5));
  • “in any other case in which a receiver may be appointed under the rules of equity” (Texas Civil Practices and Remedies Code 64.001(6));
  • to rehabilitate a domestic or foreign entity (Texas Business Organizations Code section 11.404, 11.409);
  • to liquidate a domestic or foreign entity (Texas Business Organizations Code section 11.405, 11.409);
  • to preservation and protection marital property during a divorce proceeding (Texas Family Code 6.502);
  • over the assets of a missing person (Texas Civil Practices and Remedies Code 64.001(d));
  • to preserve mineral interest or leasehold interest under a mineral lease owned by a nonresident or absent defendant (Texas Civil Practices and Remedies Code 64.091);
  • to sell property incapable of division (Texas Rule of Civil Procedure 770);
  • over property in a municipality that is not in compliance with certain life, health, and safety ordinances (Texas Local Government Code 214.0031); and
  • over property of a nonprofit housing organization that presents a life, health, or safety risk (Texas Local Government Code 214.0031).

Flexibility of Remedy

In addition to their widespread availability, state law receiverships are also valued for their flexibility and adaptability.  Under the Texas general receivership statute, a receiver is authorized to take charge and keep possession of property, receive rents, collect and compromise demands, make transfers, and perform other acts as authorized by the court.  Texas Civil Practices and Remedies Code 64.031.  Indeed, Texas courts are authorized to broadly define a receiver’s powers to accomplish the objectives of the receivership and to modify the scope of the receiver’s powers.  Texas Business Organizations Code 11.406(5) (“[The Receiver] has the powers and duties that are stated in the order appointing the receiver or that the appointing court: considers appropriate to accomplish the objectives for which the receiver was appointed and may increase or diminish at any time during the proceedings.”).  A receiver’s authority and duties are governed by the receivership order and, thus, can be tailored to each particular circumstance and the needs of the creditor. It is this flexibility that makes receivership uniquely useful to creditors.

Conclusion

Receivership is one of several remedies creditors may utilize in seeking to exercise control over a borrower or collateral.  Receiverships may be particularly attractive to creditors because they avoid the need to take possession of the property, are available in a number of circumstances, and offer flexibility that is not available under bankruptcy or other remedies.

 

 

[1] 11 USC § 303.

[2] An involuntary bankruptcy requires a trial to determine whether the debtor is paying its debts as they come due, and mandates an award of attorneys’ fees against the petitioning creditors if the court does not grant relief.  See 11 USC § 303(h).

[3] Under federal common law, a district court may use its equitable powers to appoint a receiver.  Appointment of a receiver by a federal district court is akin to the entry of an injunction and is not a statutory remedy.  Although no federal statute authorizes the appointment of a receiver, federal equity receivers are subject to a number of statutes governing their behavior.  See, e.g., 28 U.S.C. §§ 754, 2001, 2002, 2004.

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