The First Circuit looks behind a judgment still subject to appeal in deciding whether a claim is subject to bona fide dispute.

Ultimately, the appeals court upheld entry of an involuntary order for relief, but not by using the same rationale employed by the two lower courts. The opinion on Feb. 24 highlights issues regarding involuntary petitions where courts around the country are split or developing governing law.

A company was liable to a lender on four notes. The company’s owner guaranteed only two of the notes. The lender sued in a Massachusetts court, eventually obtaining a judgment against the company. The state court also entered judgment against the owner for the principal and interest on all four notes, even though only two were guaranteed.

The owner appealed, taking advantage of state law, which automatically enjoined enforcement of the judgment in some respects. The appeal was not resolved before the lender and two other creditors filed an involuntary chapter 7 petition against the owner. The debtor contended in bankruptcy court that the lender was barred from being an involuntary petitioner because there was a bona fide dispute about the “liability or amount” of the debt under Section 303(b)(1).

The bankruptcy judge entered an order for relief, rejecting the debtor’s defense by following Fourth Circuit precedent called Byrd. That case invokes only a presumption about the validity of a debt when a judgment is on appeal. The bankruptcy court examined the merits of the appeal and entered an order for relief because the debtor conceded liability for the principal on two of the notes.

On the first appeal, the district court affirmed, but on another theory. The district judge followed the Ninth Circuit’s 2013 decision in Marciano, establishing a per se rule that a claim is not subject to bona fide dispute if a judgment is “unstayed,” regardless of an outstanding appeal.

Writing for the appeals court, Circuit Judge William J. Kayatta Jr. could not invoke Marciano given the automatic stay of enforcement under state law. Although he said Marciano “has much to commend it,” Judge Kayatta wrote a footnote declining to say whether the Boston court would adopt the Ninth Circuit rule. (The Marciano rule was first espoused by retired Bankruptcy Judge Prudence Carter Beatty in 1986 in In re Drexler.)

Judge Kayatta then dealt with 2005 amendments to Section 303 that require that there be no bona fide dispute about the “liability or amount” of a claim held by an involuntary petitioner. Given the lack of legislative history, he said the courts are split on the question of whether dispute over any part of a claim renders the entire claim ineligible for use in filing an involuntary petition.

Based on a “straightforward reading” of Section 303, Judge Kayatta agreed with courts holding that “a dispute as to amount need not be material to generate a disqualifying bona fide dispute.”

Although the judgment thus became useless to support an involuntary petition, the debtor did not win because Judge Kayatta allowed the creditor to rely on the claim itself, not just the judgment. He held that a creditor does not forfeit the right to base an involuntary petition on a claim by having successfully sued and obtained a judgment.

Since the debtor conceded he was liable for the principal owing on two notes, the circuit court upheld the order for relief.