Page 4 - Corporate Restructuring & Bankruptcy

S4 | MONDAY, JUNE 13, 2016 | Corporate Restructuring & Bankruptcy | NYLJ.COM
Involuntary Bankruptcy Petition:
A Powerful Tool for Creditors
BY ERIC SNYDER AND ELOY PERAL
Creditors are often compelled to com- mence expensive and time consuming litigation to first prosecute their claims and then locate and seize a debtor’s assets. During this lengthy and costly process, the debtor’s assets are dissipated and the credi- tor may realize only a fraction of its claim. The Bankruptcy Code1 allows a trustee to liquidate a debtor’s assets in a cost-effective, expeditious manner. Because of this, involun- tary bankruptcy is a powerful tool that can expedite and maximize payments to affected creditors.
Filing an Involuntary Petition. An invol- untary bankruptcy is commenced by the filing of an involuntary petition by a “peti- tioning” creditor.2 The petition sets forth requirements for the creditor to satisfy and can be filed against an individual or business entity, other than “a farmer, fam- ily farmer, or a corporation that is not a moneyed, business, or commercial corpo- ration” and only under Chapters 7 or 11 of the Bankruptcy Code.3
A petitioning creditor is qualified to file an involuntary petition if it satisfies the follow- ing requirements: (1) it holds a claim against
ERIC SNYDER is a partner and chairman of Wilk Auslander’s bankruptcy department. ELOY PERAL is an associate at the firm.
the debtor that (a) is “not contingent as to liability or the subject of a bona fide dispute as to liability or amount” and (b) equals at least $15,3254; and (2) it demonstrates that the debtor is “generally not paying such debtor’s debts as such debts become due” (unless such debts are the subject of a bona fide dispute as to liability or amount).5 An involuntary petition may be filed by a single qualifying creditor (if the debtor has less than 12 qualifying creditors) and three or more qualifying creditors (if a debtor has 12 or more creditors).6
If an alleged debtor does not answer the petition or seek its dismissal within 21 days after service of the petition and summons, or, if there is a trial and the petitioning creditor has satisfied the statutory requirements, then the Bankruptcy Court shall “order relief ... under the chapter under which the petition was filed ... .”7 (This is the operative step resulting in the debtor being adjudicated a bankrupt and subject to Bankruptcy Court jurisdiction).
Creditors can expect debtors subject to involuntary bankruptcy to fight tooth-and- nail to avoid entry of an order for relief. Insiders of alleged debtors (officers, direc- tors, shareholders, and family members) are very reluctant to “open their kimono” and expose their financial dealings to either the transparency required under the Bankruptcy Code or the tools a bank- ruptcy trustee can use to claw-back pay- ments to these insiders made prior to the filing of the involuntary bankruptcy. Also,
if the alleged debtor is operating, the filing of an involuntary bankruptcy proceeding will not only cause vendors to immediately, and drastically, change their credit terms, but will chill the debtor’s ability to sell its goods and services to its customers. (The debtor’s competitors know who these customers are and will gladly disclose the bankruptcy filing to them).
Alleged Debtor Defenses to Involuntary Petitions. The two most litigated8 potential defenses to an involuntary bankruptcy are whether (1) the claim is subject to “bona fide dispute”; or (2) the debtor is “gener- ally not paying [its] debts as they become due.” These terms are not defined in the Bankruptcy Code.
A claim is subject to a bona fide dispute if “there is an objective basis for either a factual or a legal dispute as to the validity of [the] debt.”9 When making this determina- tion, a court is not required to resolve the dispute; but only to ascertain whether a dispute exists. The petitioning creditor has the burden to establish a prima facie case that no bona fide dispute exists, after which the debtor must present evidence sufficient to rebut the prima facie case.10 Courts have found the existence of pending litigation or the filing of an answer, or counterclaim, standing alone, insufficient to establish the existence of a bona fide dispute.11 A debtor’s previous recognition of a debt, such as list- ing the debt on a balance sheet or accounts payable ledger, has been found to be conclu- sive evidence that a debt is not in bona fide
dispute.12 Importantly, judgments obtained by default or otherwise are not considered subject to bona fide dispute in the Second Circuit.13
Whether a debtor is “generally not paying such debtor’s debts as such debts become due” calls for the consideration of four fac- tors: “(1) the number of unpaid claims; (2) the amount of such claims; (3) the materiality of the non-payments; and (4) the debtor’s overall conduct of its financial affairs.”14 The failure to pay just one significant creditor can support a finding that the debtor is generally not paying its debts.15
An involuntary petition filed by a single qualified creditor draws greater scrutiny from the Bankruptcy Court out of concern that the courts will be used as “collection agencies.”16 In those situations, alleged debtors can rely on additional defenses with varying degrees of success depend- ing upon the jurisdiction.
One line of attack is to assert that a sole creditor can never meet its burden of dem- onstrating that the alleged debtor is not gen- erally paying its debts as they become due. This argument, referred to as the “almost per se” rule, while followed in a minority of jurisdictions, has been flatly rejected in the Second Circuit, in cases where the claim of a single creditor constitutes either all or the overwhelming amount of the debts.17
Another more successful line of attack for an alleged debtor in sole creditor cases is to seek abstention or dismissal of the petition under §305 of the Bankruptcy Code even
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