In the Game of “Involuntary Petition” Poker, Tenth Circuit BAP Calls Creditor’s Bluff

Contributed by Elisa Lemmer
If you have a free moment or two on a lonely Saturday night and are looking to beef up your knowledge of “all things bankruptcy,” you might want to peruse through section 303 of the Bankruptcy Code – the section that governs involuntary cases. This seemingly unassuming section of the Bankruptcy Code packs a lot of punch because it sets a surprisingly low bar for filing an involuntary petition against a person or business.
Generally speaking, to file an involuntary petition against a person or business, section 303(b) requires three or more unsecured creditors who hold non-contingent claims, not subject to bona fide dispute, and which claims aggregate to at least $15,325. We have written before on what constitutes a bona fide dispute and on the merits of voluntary petitions, which generally limit an involuntary petition free-for-all, but if a potential debtor’s creditors can establish that their claims are not the subject of a “bona fide” dispute and they otherwise meet the Bankruptcy Code’s other criteria, then filing a meritorious involuntary petition is not that difficult to achieve. Once the petition is filed, the debtor will find itself in the middle of litigation in which the court will attempt to determine, among other things, whether the debtor was generally paying its debts as they came due. It can become an expensive and time-consuming process for a debtor who may have become the unwitting target of creditors trying to exert some pressure. What’s more, two can play the game of “involuntary petition” poker resulting in an, “I’ll see your involuntary petition, and I’ll raise you an involuntary petition of my own!”
So what provides a debtor protection from inappropriate involuntary filings? This was precisely what the Tenth Circuit Bankruptcy Appellate Panel considered in In re Wyo. Country Builders, LLC when it concluded that the best way to prevent creditors from gambling with inappropriate involuntary petitions is to hit them where it hurts most – their wallets.
In Wyo. Country Builders, Melanie M. Peterson and her husband, Kirby Peterson, had been litigating with Wyo. Country Builders (WCB) in state court since 2007. A few months before the trial was scheduled to begin, WCB filed an involuntary petition against each of the Petersons. Litigation ensued in the bankruptcy court, and almost a year later, the bankruptcy court dismissed each of the involuntary petitions finding that the “three-petitioning-creditors-standing” requirement contained in section 303(b) had not been met. The Petersons sought sanctions against WCB. At the evidentiary hearing on the Petersons’ request for sanctions, WCB’s counsel advised the court that WCB’s owner had assigned his claim to a third party such that the third party was the new party in interest in the matter. Absent any evidence of any such assignment, the bankruptcy court characterized the alleged assignment as “game playing.” The Petersons eventually, through their attorney, applied for attorneys’ fees under section 303(i) of the Bankruptcy Code.
Section 303(i) provides that if a court dismisses an involuntary petition for reasons other than on consent of all the parties, and if the debtor does not waive the right to judgment, the court may grant judgment in favor of the debtor and against the petitioners for costs or reasonable attorneys’ fees or the court may grant a judgment in favor of the debtor and against any petitioner who filed the petition in bad faith for any damages caused by the filing or punitive damages. In April 2010, the bankruptcy court entered an order awarding fees to the Petersons’ attorney (as opposed to the Petersons themselves). Through a series of assignments, in August 2012, the Petersons acquired their attorney’s fee award. It appears that the Petersons attempted, albeit unsuccessfully, to use the fee award as leverage in their settlement negotiations with WCB.
The following October, Melanie Peterson filed an involuntary petition against WCB relying (ironically) on the fee award entered in her own involuntary case to establish standing to file WCB’s involuntary case. In support of the involuntary petition, Peterson stated that the fee award claim was transferred “in the hopes that it could be used as leverage…[in] the pending litigation” but that WCB had failed to consider the fee award in its settlement negotiations in the action. She also stated that the claim was not transferred to her for the purpose of filing the involuntary petition.
WCB sought to dismiss the involuntary petition against it contending that Peterson’s claim was the subject of bona fide dispute. The bankruptcy court dismissed the petition concluding that Peterson had “improperly filed the involuntary petition after her attempt to use the [fee award] in settlement discussions in the state court litigation failed and as a substitute for collection.” The court also concluded that fees and costs would be awarded in favor of WCB and awarded punitive damages against Peterson. Peterson appealed the award of fees and costs (but did not appeal the award of punitive damages).
Analysis and Holding
The Tenth Circuit Bankruptcy Appellate Panel began its analysis by observing that a bankruptcy court’s decision to award attorney’s fees and costs under section 303(i) is reviewed for abuse of discretion. Translation: unless the bankruptcy court’s decision was completely unsupportable, it was highly likely that the appellate court would affirm. Turning to section 303(i), the court noted that the section is permissive – allowing a court to use its discretion in determining to award fees, costs and damages. Consequently, if an involuntary petition is dismissed (other than by consent of the parties) and a motion under section 303(i)(1) is filed seeking costs and fees, there is a rebuttable presumption that the costs are authorized. The court observed that, in reviewing an application for such fees and costs, courts consider the following factors: (1) the merits of the involuntary petition, (2) improper conduct by the debtor, (3) the reasonableness of the petitioning creditors’ actions, (4) the motivation behind the filing of the petition and (5) any other relevant considerations. Although Peterson tried to argue that the third party to whom WCB had originally assigned its interest in the matter was the “true debtor” in the case, the Tenth Circuit BAP disagreed, observing that the involuntary petition filed by Peterson named WCB as the debtor (not the third party). The court likewise rejected Peterson’s argument that the bankruptcy court failed to consider WCB’s “game playing,” observing that any alleged “game playing” occurred in Peterson’s involuntary case not WCB’s case, so the bankruptcy court in WCB’s case was entitled to accord any such “game playing” little to no weight. Instead, the court concluded that Peterson’s action “was more egregious since she chose to use the same door the Bankruptcy Court previously slammed against WCB.”
At the end of the day, whether WCB or Peterson was the real “game-player” is not as important as the valuable lesson instilled by the bankruptcy court in both of their cases (and later affirmed by the Bankruptcy Appellate Panel in WCB’s case): while it may be easy to file an involuntary petition, creditors should think long and hard before they do so. Filing an inappropriate voluntary petition is a game that a creditor is sure to lose.