Dismissal of Involuntary Petition Can You Buy Your Way Out

Journal Issue

Dec/Jan 2001

Column Name

Journal HTML Content

As a follow-up to the October 2001 Practice and Procedure article, "<a href="/abidata/online/journaltext/01octpractice.html">Exceptions
to Involuntary Petition Requirements: Are you Pushing Your Luck</a>," additional issues
regarding the filing and potential dismissal of an involuntary bankruptcy merit
discussion. After all, upon the filing of an involuntary petition, the alleged
debtor, as such are called during the period between the filing of an involuntary
petition and the entry of an order of relief, will typically want to dismiss the
involuntary petition by whatever means necessary, including paying one or more of the
petitioning creditor's claims.

In fact, such desperation may cause the alleged debtor to take drastic measures
in dealing with its creditors. Such measures may include expending large sums of money
to eradicate the problem, seen here as the petitioning creditors. Indeed, the filing
of an involuntary petition will often raise a spite fence where one may or may not
have previously existed. Such measures are not necessarily successful, as most courts
have intervened in such attempts.

<h3>Involuntary Petitions Under the Bankruptcy Code</h3>

Pursuant to <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §303</a>, an involuntary bankruptcy case under chapter 7
or 11 may be commenced against an individual or entity that may be a debtor under
the chapter under which such case is commenced. Generally, an involuntary case is
commenced by the filing of a petition:

<ol>
<li>by three or more entities, that hold claims that are not contingent or subject
to bona fide dispute, if the claims of such entities aggregate at least
$10,775 more than the value of any lien on property securing such claims;
or

</li><li>if there are fewer than 12 claim holders, by one or more of such holders
that hold in the aggregate at least $10,775 of such claims.
</li></ol>

See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §303(b)</a>.

Section 303 further states that the court shall order relief against the debtor,
only if:

<ol>
<li>the debtor is generally not paying its debts as such debts become due, unless
such debts are the subject of a bona fide dispute; or

</li><li>within 120 days before the petition date, a custodian was appointed or took
possession of substantially all of the debtors' property.
</li></ol>

See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §303(h)</a>.

If less than three creditors filed the involuntary petition against an alleged
debtor with 12 creditors, dismissal would be proper. One exception was discussed
in the October 2001 ABI Journal in connection with the "special circumstances"
exception recognized by many courts. When such special circumstances do not exist,
however, the lack of three petitioning creditors results in a dismissal of the
involuntary petition.

Many alleged debtors have attempted to create the grounds for dismissal by reducing
the number of petitioning creditors. Theoretically, the number of petitioning creditors
could be reduced by paying the petitioning creditor in full. Thus, all the alleged
debtor need do is make payment in full to the smallest petitioning creditor.

As stated below, however, such means are not accepted by courts as a valid ground
for dismissing an involuntary bankruptcy due to the policy considerations involved.

<h3>Payment of Petitioning Creditors' Claims</h3>

Pursuant to §303(h), an alleged debtor may contest the entry of an order for
relief due to the filing of an involuntary petition. If less than three petitioning
creditors exist, then the requirements of §303(b)(1) are not satisfied (assuming
that the alleged debtor has less than 12 creditors). Further, if the alleged
debtor paid off each of the petitioning creditors, then no party would exist to
contest a motion to dismiss or the alleged debtor's evidence as to whether it is
generally paying its debts as they become due.

Both strategies assume, however, that no additional creditors join in the
involuntary petition as contemplated by §303(c). Such joinder would undermine the
alleged debtor's attempts to subvert the involuntary filing and/or require additional
payments to petitioning creditors. More importantly, many courts have held that an
alleged debtor cannot avoid an involuntary bankruptcy petition by merely paying creditors.
See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re All Media Properties Inc.,</a><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 5 B.R. 126 (S.D. Tex. 1980)</a>;
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Faberge Restaurant of Florida Inc.,</a><a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 222 B.R. 385 (S.D. Fla.
1997)</a>.

In All Media, the alleged debtor paid one of its three petitioning creditors in
full after the filing of the involuntary petition. The alleged debtor asserted that
the paid creditor could no longer be considered a petitioning creditor, thereby
defeating §303(b)(1)'s requirements. The court, however, held that satisfaction
of a claim after the filing of an involuntary petition does not deprive the court of
jurisdiction. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Media, 5 B.R. at 137</a>; citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Thornton, 43
F.2d 813 (9th Cir. 1930)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Gibraltor Amusements Ltd., 187
F.Supp. 931, 937 (E.D.N.Y. 1960)</a>, aff'd., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… F.2d 22
(2d Cir. 1961), cert. den., 368 U.S. 925, 82 S.Ct. 360,
7 L.Ed.2d 190 (1961)</a>. In fact, not only did All Media hold that the
court did not lose jurisdiction, but that the petitioning creditor also did not lose
its status as a petitioning creditor. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Media, 5 B.R. at 137</a>.

Similarly, in Faberge, two petitioning creditors received payment after the petition
date, and the alleged debtor moved to dismiss because of the lack of standing of
those petitioning creditors. In response, the court held that "policy reasons, and
other considerations, dictate that the post-petition payments will not deprive the court
of jurisdiction or require the dismissal of the petition." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 222 B.R.
at 388</a>; citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Thorton, 43 F.2d 813 (9th Cir. 1930)</a>;
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Sjostedt, 57 B.R. 117, 120 (Bankr. M.D. Fla. 1986)</a>;

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Claxton, 21 B.R. 905 (Bankr. E.D. Va. 1982)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Carvalho Industries Inc., 68 B.R. 254 (Bankr. Ore. 1986)</a>. Based
thereon, the court refused to dismiss the alleged debtor's involuntary bankruptcy.
Thus, despite what would seem an otherwise logical inference, an alleged debtor cannot
avoid the consequences of the filing of an involuntary petition by merely making payment
to the petitioning creditors.

None of these cases, however, dealt with circumstances where the alleged debtor paid
all of the petitioning creditors in full. Payment of all petitioning creditors would
lead, theoretically, to a lack of any party to contest the alleged debtor's assertions
that its debts were paid as they became due. Because of the lack of controverting
evidence, it seems possible to defeat an involuntary petition by paying all petitioning
creditors' claims, assuming again that no joinder occurs.

<h3>Conclusion</h3>

The desire to derail an involuntary bankruptcy petition is a natural reaction to an
extreme remedy at law. Derailing an involuntary bankruptcy, however, is not as easy
as one might first assume. In fact, policy reasons dictate the result based on the
concept of protecting other creditors of the estate. The old adage remains true:
Filing bankruptcy is very easy, but exiting bankruptcy can be very difficult.

Journal Authors

Bruce H. White

William L. Medford

Journal Date

Saturday, December 1, 2001 - 12:00

Bankruptcy Rule

2001