Creditors seeking to file an involuntary petition against a debtor may want to consider doing their due diligence before using it as a tool in their ongoing disputes with a debtor.  In In re Metrogate, LLC f/k/a Advance Realty Group, LLC, the United States Bankruptcy Court for the District of Delaware rebuked the petitioning creditors for filing an involuntary petition that the court concluded plainly failed to meet the statutory requirements under section 303 of the Bankruptcy Code and also was filed as a bad faith litigation tactic of forum shopping.  
The Beginning of an Acrimonious Dispute
In October of 2005, Metrogate LLC created two Delaware statutory trusts, which in turn issued $60 million of trust preferred stock (often referred to as “TruPS”) to four collateralized debt obligation funds managed by TP Management LLC.  As is typical of a TruPS structure, the trusts lent the proceeds to Metrogate.  As Metrogate repaid its loans (which were subordinated to most of Metrogate’s other debts), the trusts would make distributions on the TruPS.
In 2007 and 2008, Metrogate underwent a restructuring involving a spinoff of one of its subsidiaries, which TP Management alleged had the effect of structurally subordinating the trusts’ payment rights to those of other creditors.  In 2008, TP Management intervened in a Delaware shareholder action alleging fraud and breach of fiduciary duty claims against Metrogate in connection with the restructuring.  The Delaware state court dismissed the shareholder action.  Shortly thereafter, in 2009, Metrogate stopped repaying the trusts, which in turn stopped paying the TruPS.  Consequently, from 2009 through 2013, TP Management sent Metrogate various notices of default under the transaction documents governing the statutory trusts.  Despite the notices and failure to make payments, Metrogate did not resume payments or admit that it had defaulted under the transaction documents.
Not willing to go gently into the night, in 2013, TP Management, on behalf of certain of the TruPS holders, sued Metrogate in New York state court for, among other things, breach of contracts, fraudulent conveyance, piercing the corporate veil, and unjust enrichment.  As part of the discovery process, TP Management uncovered documents allegedly showing that Metrogate had been paying interest on insider loans.  In late 2015, TP Management filed an involuntary petition against Metrogate on behalf of the TruPS holders, asserting that it was doing so to prevent further diminution of Metrogate’s assets.
Metrogate moved to dismiss the involuntary petition on the bases that the petition not only failed to meet the statutory requirements of section 303, but was also filed as a bad faith litigation tactic by TP Management in connection with the New York state court litigation.  The Delaware bankruptcy court agreed, found that the involuntary petition was filed in bad faith, and accordingly dismissed the petition.
Statutory Requirements Under Section 303(b)
Under section 303(b)(1) of the Bankruptcy Code, an involuntary bankruptcy case is commenced upon the filing of a petition by at least three creditors (known as the “numerosity requirement”) that hold, in the aggregate, at least $15,325 in unsecured claims that are not subject to bona fide dispute as to liability or amount.  Metrogate argued that TP Management, representing the four TruPS holders, failed to satisfy section 303(b)(1) because the four holders collectively held only two claims against Metrogate – one arising from each of the Delaware statutory trusts that issued the notes.  The Delaware bankruptcy court found that, under the governing transaction documents, each holder could separately enforce its claim directly against Metrogate without joinder from the other holders, so the four holders satisfied the numerosity requirement.
The Delaware bankruptcy court nevertheless found that TP Management failed to establish a prima facie case that the claims were not subject to a bona fide dispute. Metrogate claimed that the issue of whether it was in default was being litigated in the New York state court and asserted that it was not in default because, even though Metrogate had not paid the TruPS, it was required to pay certain senior debt owed to other creditors before paying the TruPS.  TP Management, however, argued that Metrogate readily admitted in its financial statements that it had failed to pay the TruPS, and, therefore, there was no bona fide dispute regarding liability for the $60 million TruPS.
The bankruptcy court found that the TruPS were subject a bona fide dispute through the ongoing New York state court litigation – in fact, just eleven days before TP Management filed the involuntary petition, Metrogate filed an answer in the New York state court litigation with 26 defenses and two counterclaims, meaning that a final decision on whether Metrogate breached the transaction documents and Metrogate’s ultimate liability for the TruPS was still undecided.  The Delaware bankruptcy court noted that Metrogate’s counterclaims and affirmative defenses in the New York state court litigation, if successful, would call into question a substantial amount of the ultimate amount owed by Metrogate, which therefore was sufficient to constitute a “bona fide dispute” under section 303.
As put by the bankruptcy court, “[t]o say that there are no bona fide disputes involved here would be extraordinary[.]”
Damages for Bad Faith Filing Under Section 303(i)
Not satisfied with just dismissing the involuntary petition, Metrogate also sought damages in connection with the involuntary filing.  Under section 303(i) of the Bankruptcy Code, a bankruptcy court may enter judgment for proximate or punitive damages based on a petitioning creditor’s bad faith filing.  The bankruptcy court, applying the factors set forth in the Third Circuit’s recent Forever Green decision, found that the involuntary petition was filed in bad faith.  Specifically, the bankruptcy court found the following Forever Green factors relevant:

  • Statutory Criteria: The bankruptcy court examined whether TP Management satisfied the statutory criteria under section 303 and found (including for the reasons discussed above) that TP Management failed to satisfy the criteria from an equitable perspective.  Specifically, TP Management “made no effort whatsoever” to seek out other creditors in joining the involuntary petition.  The dispute appeared to be “functionally between two parties” with TP Management as a “recalcitrant creditor” concerned more with collecting debts than Metrogate’s well-being as a going concern.
  • Meritorious Involuntary Petition: The bankruptcy court examined whether the involuntary petition was meritorious and found that TP Management failed to present evidence that Metrogate was insolvent or dissipating assets, and further found that the insider loans were necessary during a period of financial crisis to keep Metrogate running, not to siphon assets.
  • Reasonable Inquiry: The bankruptcy court examined whether TP Management made a reasonable inquiry into the relevant facts and pertinent law before filing and found that TP Management failed to do so.  The court found TP Management’s motivation for filing the involuntary petition – Metrogate’s alleged concealment of transaction documents for the 2008 restructuring and insider loans – “disingenuous,” especially because TP Management would have discovered Metrogate’s disclosure of such documents by scrutinizing Metrogate’s public court documents and financial statements, instead of merely “skimming” them as TP Management admitted it did.
  • Preferential Payments: The bankruptcy court examined whether there was evidence of preferential payments to creditors or of dissipation of Metrogate’s assets and found that its insider loans were made at market rates, and therefore were not preferential payments.
  • Ill Will: The bankruptcy court examined whether the involuntary petition was motivated by ill will or a desire to harass and found, in simple terms, that the “dispute has the acrimony of a protracted fight that has now occupied three venues.”
  • Timing: The bankruptcy court examined whether the timing for TP Management’s filing was suspicious and found that TP Management’s filing of the involuntary petitions just eleven days after Metrogate filed multiple defenses and counterclaims in the New York state court action “telling.”  The bankruptcy court found that the timing was “directly in response to pending state actions.”

Based on the above factors, the bankruptcy court found that TP Management filed the involuntary petition against Metrogate as a bad faith litigation tactic of forum shopping.  Despite the finding of bad faith, the court noted that damages under section 303 were permissive – not mandatory – and in the court’s view, there were “no angels involved on either side of th[e] dispute.” Consequently, the court strongly encouraged the parties to meet and discuss a settlement.
The Metrogate decision is one of the first decisions to dismiss a case by applying the Forever Green factors and serves as a reminder to creditors that just like filing a voluntary petition, filing an involuntary petition is a monumental decision that should be made with care.  Although the Metrogate court declined to award damages based on both parties’ behavior, a creditor’s failure to exercise care could result in damages the next time a more “innocent” debtor is involved.
Daniel Gwen is an Associate at Weil Gotshal & Manges, LLP in New York.