Alliotts Bankruptcy Article Involuntary Proceedings

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MONDAY, JULY 18, 2005

BANKRUPTCY LAW Involuntary Proceedings By Craig Rankin and Christopher Alliotts

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s part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Congress made certain modifications to § 303 of the Bankruptcy Code, 11 U.S.C. 303. Section 303 sets forth the requirements that petitioners must satisfy in order to commence involuntary bankruptcy proceedings and for the subject entity to be adjudged a debtor for purposes of such proceedings. This article considers the extent, if any, to which the modifications to § 303 change existing law, as applied by the courts. Under the prior version, § 303(b)(1) provided in pertinent part that an involuntary case is commenced by the filing of a petition by three or more entities, each of which is a holder of an unsecured claim against such person “that is not contingent as to liability or the subject of a bona fide dispute,” if the amount of such claims aggregate the statutory minimum, which is currently $12,300. (If the putative debtor has fewer than 12 creditors, excluding employees or insiders of the putative debtor, one person may file.) The new law changed § 303(b)(1) by adding “as to liability or amount” after “bona fide dispute.” The prior version of § 303(h)(1) provided that, if an alleged debtor contests the filing of the involuntary petition under § 303(b)(1), the court, after trial, shall order relief against the debtor only if it is generally not paying its debts

Craig Rankin is a partner at Los Angeles-based bankruptcy boutique Levene, Neale, Bender, Rankin & Brill. Christopher Alliotts is of counsel to the Menlo Park, Calif., office of Los Angeles-based SulmeyerKupetz.

as they become due “unless such debts are the subject of a bona fide dispute.” Similar to § 303(b)(1), the new law changes § 303(h)(1) by adding “as to liability or amount” after “bona fide dispute.”

Retroactive application will not violate Constitution As an initial matter, the new law provides that these amendments shall take effect upon enactment and shall apply with respect to cases commenced “before, on and after such date.” In other words, the amendments are supposed to be applied retroactively. Retroactivity instinctively raises questions of fairness; however, the U.S. Supreme Court has held that application of an intervening statute that confers or ousts jurisdiction or changes procedural rules in suits arising before its enactment does not raise constitutional concerns. Because § 303 is considered a jurisdictional statute, coupled with the general principles that bankruptcy relief is a privilege and not a constitutional right, it is clear that the retroactive application of these amendments, even if they alter existing law, will not violate the Constitution. See In re BDC 56 LLC, 330 F.3d 111 (2d Cir. 2003). Courts have distilled three substantive

requirements for an involuntary petition to be valid under § 303: There must be at least three petitioning creditors (only one if the debtor has fewer than 12 creditors); each petitioning creditor must hold unsecured claims against the debtor not subject to bona fide dispute and totaling at least $12,300; and the debtor is generally not paying debts as they come due. In re Focus Media Inc., 378 F.3d 916 (9th Cir. 2004); In re Amanat, 321 B.R. 30 (Bankr. S.D.N.Y. 2005). While the requirement to have at least three petitioning creditors is straightforward enough, creditors are often reluctant to join in the filing of such a petition because, if the involuntary petition is dismissed, they could be facing severe consequences under § 303(i). Further, there is the risk that a debtor could successfully show that related entities should be deemed to be one and the same creditor. Also, creditors pushing for an involuntary filing should be mindful of the prohibition in Rule 1003 of the Federal Rules of Bankruptcy Procedure of assigning claims for the purpose of commencing an involuntary case. See, e.g., Focus Media, supra. The term “bona fide dispute” is not defined in the Bankruptcy Code. While courts have articulated different standards, they have settled on one in recent years requiring that there be “an objective basis for either a factual or a legal dispute as to the validity of the debt.” In other words, a bona fide dispute exists only when “there are substantial factual or legal questions that bear upon the debtor’s liability.” In re Byrd, 357 F.3d 433 (4th Cir. 2004). Under this standard, the petitioning creditors bear the burden of a prima facie showing that no bona

fide dispute exists and, upon that showing, the burden shifts to the debtor to demonstrate that there is such a dispute. Because the filing of an involuntary petition may, under appropriate circumstances, be part of valid collection efforts, courts have often disagreed on the preclusive effect that state court proceedings should have on the question of whether a dispute satisfies th5 Tw2ee f93085 Some lowhetts, courts htakeed on tos peti tate