Restructuring

Contributed by Andrea Saavedra
When learning to cook pasta al dente, you may have been told to “throw it against the wall and see if it sticks.”  While this technique has become an oft-used idiomatic expression that generally means to “give it a go and see what happens,” it may not be prudent advice in the context of litigation.  Not only are meritless claims subject to dismissal, but baseless allegations could lead to sanctions by a court against the litigant and/or its counsel.  A recent decision by Judge Glenn of the Bankruptcy Court for the Southern District of New York, In re TPG Troy, serves as a reminder that a scattershot approach to litigation may not reap better or faster rewards.
In TPG Troy, three petitioning creditors had filed involuntary chapter 7 petitions against two Delaware limited liability companies.  Interestingly, the LLCs not only had been dissolved more than five years prior to the commencement of the chapter 7 cases, but were not even in contractual privity with the petitioners, which were holders of certain bonds issued by two of the alleged debtors’ foreign affiliates.  Nevertheless, the petitioners sought to recover their debts against the LLCs on a theory of alter ego liability, which the LLCs stridently contested.
Significantly, the bankruptcy court was not the first – or only – forum in which the petitioners were pursuing similar, if not identical, claims against the LLCs.  Prior to commencement of the involuntary cases, the petitioners had commenced twelve separate actions against the alleged debtors in a variety of federal and state courts, most of which were still pending.  In addition, one of the bond-issuing foreign affiliates of the LLCs, which was in contractual privity with the petitioners, was itself a debtor in an English insolvency proceeding (which proceeding had already been granted chapter 15 recognition by the bankruptcy court).  In other words, the petitioners were not simply taking some pasta and throwing it against the wall – they had taken all of their pasta and thrown it against every wall in the U.S. court system that they could find.
The LLCs moved to dismiss the petitions on various grounds.  They asserted that, given their prepetition dissolution, the LLCs could not qualify as “debtor” entities for purposes of the Bankruptcy Code.  They also argued that, assuming that the LLCs could even qualify as debtors, any purported debt of the LLCs to the petitioners was the subject of a “bona fide” dispute, and, therefore, the petitioners were not creditors eligible to file involuntary petitions under section 303(b)(1) of the Bankruptcy Code.  Finally, the LLCs urged the bankruptcy court, if it were inclined to consider the petitions, to abstain pursuant to section 305(a)(1) of the Bankruptcy Code because the interests of all parties involved would be better served by dismissal, particularly in light of the pending non-bankruptcy litigations that centered on the same set of facts and theory of liability.  The LLCs asked the bankruptcy court to award them fees, costs, and damages under section 303(i) of the Bankruptcy Code because, they claimed, the involuntary petitions had been filed in bad faith.
In response, the petitioners argued that, despite their dissolution, the LLCs clearly were operational given their retention of “competent and expensive” counsel; there was no “bona fide” dispute as to the debts alleged, solely as to the theory pursuant to which they were owed; and abstention would not be in the best interests of all creditors where, among other things, creditors would be deprived of the derivative protections provided to them vis-à-vis the rights and powers (including avoidance) of a chapter 7 trustee.
Judge Glenn decided that the cases had to be dismissed because the debt allegedly owed to the petitioners was “hotly contested.”  Specifically, section 303(b)(1) provides that an involuntary case can only be commenced by an entity that is a “holder of a claim” against the debtor that is neither “contingent as to liability” nor the “subject of a bona fide dispute.”  While pending litigation between a creditor and debtor does not, in and of itself, establish the existence of a bona fide dispute, the bankruptcy court determined that the nature, substance, and litigation posture of the various prepetition litigations (including upcoming oral arguments in two matters before New York state courts) supported a finding of a bona fide dispute.
The bankruptcy court also found that dismissal was appropriate pursuant to section 305(a)(1), which permits dismissal where the court finds that the “interests of creditors and the debtors would be better served by such dismissal[.]”  Analyzing various factors in determining best interests, the bankruptcy court concluded that “multiple” forums were available to protect the interests of both parties given the variety of prepetition litigations.  Indeed, the bankruptcy court noted that it was “questionable” as to whether the chapter 7 petitions had been filed for a “proper purpose” in the first instance, given the prepetition plethora of litigations.  While it determined that a finding on the effect of the dissolution of the LLCs was unnecessary to grant dismissal, the bankruptcy court observed that the fact of dissolution supported dismissal as, generally, a corporation that is not a “moneyed, business, or commercial corporation” cannot be a debtor under section 303(a) of the Bankruptcy Code.  The bankruptcy court concluded by inviting the LLCs to pursue attorneys’ fees, costs, and damages to the extent that they are able to establish that the petitions were filed in “bad faith,” as provided for pursuant to section 303(i).
Given the history of forum shopping by the petitioners, dismissal may not strike many as surprising.  It is notable, though, because it reminds creditors that, while an involuntary filing may provide certain tactical advantages, it is not a foolproof method of making your claims stick – in fact, if it is just one of many avenues of collection on the same facts against the same parties, it may be, metaphorically speaking, the equivalent of overcooking your pasta.