Ninth Circuit Bars Third Parties from Seeking Damages for Dismissal of an ‘Involuntary’

Over a dissent, the Ninth Circuit held on April 29 that a 50% shareholder of an involuntary debtor cannot seek damages for dismissal of the involuntary petition, even if the debtor itself was deadlocked and unable to act in response to the petition.

The involuntary corporate debtor had two 50% shareholders. A vote of two-thirds of the board or of the shareholders was required for the company to act.

According to the dissent by Circuit Judge Mark J. Bennett, one 50% shareholder wanted to liquidate the debtor over the objection of the other. A creditor, who was a contingent shareholder, filed an involuntary petition.

The debtor corporation was deadlocked and unable to respond to the involuntary petition. The 50% shareholder who opposed liquidation filed a motion to dismiss the petition. According to the dissenter, the opposing shareholder also sought attorneys’ fees and damages on behalf of the involuntary debtor.

According to the majority opinion by Fourth Circuit Judge Stephanie Dawn Thacker, sitting by designation, the petitioning creditor conceded at the hearing on the motion to dismiss that dismissal was proper. However, the bankruptcy court ruled that the opposing shareholder who won dismissal lacked standing to seek damages and attorneys’ fees.

To read ABI’s report on the affirmance in district court ruling that the shareholder could not seek damages, click here.

If the court dismisses a petition, Section 303(i) provides that “the court may grant judgment—

(1) against the petitioners and in favor of the debtor for—

(A) costs; or

(B) a reasonable attorney’s fee; or

(2) against any petitioner that filed the petition in bad faith, for—

(A) any damages proximately caused by such filing; or

(B) punitive damages.”

Note that the phrase “in favor of the debtor” appears in subsection (1) but not in (2).

Upholding the lower courts, Judge Thacker in substance ruled for the majority that the case was controlled by Miles v. Okun (In re Miles), 430 F.3d 1083 (9th Cir. 2005). She appeared to read Section 303(i) as meaning that a non-debtor cannot seek damages for dismissal of an involuntary petition.

Judge Thacker based her conclusion on Miles, legislative history, an opinion by the Ninth Circuit Bankruptcy Appellate Panel, and the purpose of the statute to “alleviate the consequences that involuntary proceedings impose on the debtor.” She said that a third party “does not face those consequences.”

Dissenting, Judge Bennett said that the majority read Miles to mean that a third party who defeats an involuntary petition “can never request that the debtor be awarded costs, a reasonable attorney’s fee, or damages.” “Miles never went so far,” he said. The majority’s opinion, in his view, was “inconsistent with both the relevant statutory authority and the policies underlying the Bankruptcy Act.” [sic.]

Judge Bennett emphasized how the shareholder was seeking damages and attorneys’ fees “on behalf of the debtor.” He cited a bankruptcy court in Illinois, where someone who was in “a close relationship with the debtor” was permitted to collect damages and fees. In re Fox Island Square Partnership, 106 B.R. 962, 968 (Bankr. N.D. Ill. 1989).

The shareholder should have been allowed to seek fees and damages because it “was truly the only party willing and able to act” for the deadlocked corporate debtor. He distinguished Miles, because it involved “true third parties.” On the other hand, the opposing shareholder, he said, was “not such an independent third party — it was acting as a 50% shareholder during a corporate governance breakdown.”

Judge Bennett would have remanded the case for the bankruptcy court to determine whether anyone else could have opposed on behalf of the debtor and whether the petition was filed in bad faith. If the answers came in the right way, he would have allowed the bankruptcy court to fix appropriate fees and damages “in light of the totality of the circumstances.”