Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.
By Diane Davis
Oct. 22 — An involuntary bankruptcy petition filed against artificial turf maker Forever Green Athletic Fields by its creditors may be dismissed for bad faith, the Third Circuit held Oct. 16.
Judge Julio M. Fuentes of the U.S. Court of Appeals for the Third Circuit concluded that even though the creditors met the statutory requirements for filing an involuntary petition under Bankruptcy Code Section 303, the petition may still be dismissed as a bad faith filing.
The appeals court agreed with the bankruptcy court that creditors who filed petitions to collect on a personal debt, to gain an advantage in pending litigation, or to harass the debtor, act in bad faith.
Section 303(b)(1), which governs involuntary cases under Chapters 7 and 11, provides three requirements for commencing an action against a debtor who has 12 or more creditors: “(1) there must be three or more petitioning creditors; (2) each petitioning creditor must hold a claim against the debtor that is not contingent as to liability or the subject of a bona fide dispute; and (3) the claims must aggregate at least $15,325 more than the value of liens on the debtor's property.”
Charles Dawson, owner of competitor artificial turf maker ProGreen and a former Forever Green sales representative, his wife Kelli Dawson, and the law firm Cohen Seglias Pallas Greenhall & Furman filed an involuntary Chapter 7 bankruptcy petition against Forever Green.
The Dawsons had previously sued the debtor for unpaid commissions and wages, and even though they had a $300,000 judgment from a Louisiana court, the debtor had not paid a penny on the judgment.
The case had gone into arbitration, but ProGreen filed a motion to terminate the arbitration once the consent judgment was entered in Louisiana. The Dawsons then transferred their judgment to Pennsylvania and obtained a writ of execution against the arbitrator and his law firm, who suspended the arbitration until the fee issue was resolved.
The debtor then filed a complaint in state court trying to reinstate the arbitration. Shortly thereafter, the Dawsons and the law firm Cohen Seglias Pallas Greenhall & Furman, which was owed $206,000 from the debtor, filed an involuntary bankruptcy petition against Forever Green.
After an evidentiary hearing, the bankruptcy court determined that Forever Green had $6 million in assets, with $2.3 million in debts, including a $1.3 million secured line of credit. According to the court, although Forever Green had not been paying any of its debts, its founder, Keith Day, had been personally paying off some of the company's debt for which he had “financial guarantees.” Day was also funding the company's current litigation.
The bankruptcy court ruled in Forever Green's favor and dismissed the case. According to the bankruptcy court, Dawson was a bad-faith creditor because he was motivated by two improper purposes: to frustrate the debtor's efforts to litigate its claim against ProGreen, and to collect on a debt.
The district court affirmed, and the Dawsons appealed to the Third Circuit.
Dawson argued that courts may engage in a bad-faith inquiry only after they have dismissed a case for the creditor's failure to comply with the statutory filing requirements.
The Third Circuit disagreed with Dawson, concluding that a better view is that, “by including an express reference to bad faith in § 303, Congress intended for bad faith to serve as a basis for both dismissal and damages.”
Section 303(i)(2), the court said, “allows a bankruptcy court to award damages following dismissal against “any petitioner that filed the petition in bad faith.”
Emphasizing the “equitable nature of bankruptcy,” the court noted that most courts agree that there is a “good faith” failing requirement in the context of involuntary petitions for bankruptcy. The Third Circuit also found policy reasons for allowing the dismissal of bad-faith filings. It will encourage creditors to file petitions for proper reasons such as to protect against the preferential treatment of other creditors or the dissipation of the debtor's assets, the court said.
In determining the standard for evaluating bad faith, the appeals court noted that there are different tests such as improper use, improper purpose, and objective test. The Third Circuit, however, adopted the “totality of the circumstances” standard for determining bad faith under Section 303.
Looking at the totality of the circumstances, the court found that the bankruptcy court didn't abuse its discretion in finding that Dawson filed the involuntary petition in bad faith.
The Third Circuit declined to take a stance on the “bar to joinder” rule because it was too late for any creditor to save the petition. Under the “bar to joinder” rule, a petition that was filed in bad faith can't be saved by joining good-faith creditors under Section 303(c) prior to dismissal. The court noted that most courts find this type of curing impermissible, but there is a minority of courts that finds this rule unjustified because it lumps good- and bad-faith filers together and punishes everyone.
There is no evidence that any creditor tried to join the petition before the case was dismissed, the court said. That leaves only two good-faith creditors when the statute requires three, the court said.
Senior Judges Richard Lowell Nygaard and Jane R. Roth joined the opinion.
Aris J. Karalis, Robert W. Seitzer, Maschmeyer Karalis, Philadelphia, represented debtor Forever Green Athletic Fields, Inc.; and Steven K. Eisenberg, Stern & Eisenberg, Warrington, Pa., represented appellants Charles C. Dawson and Kelli Dawson.
To contact the reporter on this story: Diane Davis in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Jay Horowitz at email@example.com
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