Section 303 of the Bankruptcy Code provides a unique remedy to unsecured creditors seeking to collect their debts against an insolvent entity. A careful look at this remedy is contained in an earlier post, entitled Creditors’ Strategic Use of Involuntary Bankruptcy. In summary, pursuant to section 303, three unsecured creditors, with claims in the aggregate of $15,775, can place an insolvent company in bankruptcy provided their claims are not “contingent as to liability or the subject of a bona fide dispute as to liability or amount.” 11 U.S.C. § 303(b)(1). The petitioning creditors must also show that the debtor is generally not paying its debts as they come due. 11 U.S.C. § 303(h)(1).
In In re General Aeronautics Corporation, Case No. 17-28510 (Bankr. D. Utah Dec. 4, 2018), the Bankruptcy Court for the District of Utah carefully reviewed one of the more heavily-debated issues regarding section 303(b), whether a creditor with a partially disputed claim has standing to initiate an involuntary petition. In a thorough opinion, Judge Mosier determined that such creditors do have standing. A summary of his detailed opinion is provided below.
With great difficulty, including sporadic shortfalls in funding, General Aeronautics Corporation (“GAC”) tried to build and market gyroplanes for over 30 years. Despite its long-history, however, GAC never transitioned beyond being a mere development company.
During GAC’s last funding shortfall in early 2015, many of its remaining employees (who were owed substantial compensation) resigned or were laid off. Before the 2015 layoffs, GAC’s officers had promised non-executive employees deferred compensation and bonuses to induce them to continue working. After the layoffs, these employees were never paid. Several executives of GAC similarly had claims for unpaid compensation, bonuses and loans made to the Company.
Apart from the employees, the former landlord of GAC claimed that he was owed significant past-due rent, some of which dated back several years to GAC’s predecessor. From GAC’s scantily kept books and records, it also appeared that it had not paid significant older debts to third parties.
When the Company received $5 million in new funding in late 2016, its creditors joined to consider their options. In September 2017, several former executives and non-executives and the former landlord filed an involuntary bankruptcy petition against GAC, pursuant to section 303 of the Bankruptcy Code.
At the time, GAC had no revenues and was paying substantial monthly expenses with the limited funding it received in 2016. But, GAC’s cash reserve was diminishing quickly. Moreover, while GAC was staying current on its monthly expenses, it (and its predecessor) had already amassed significant debts (approximately $2.4 million), dating back to 2012, and these older debts went largely ignored for several years.
Notwithstanding its financial outlook, GAC filed a motion to dismiss the involuntary case, arguing that the petitioning creditors lacked standing under section 303(b)(1), because their claims were the subject of a bona fide dispute as to liability or amount. The petitioning creditors maintained, however, that they had standing as long as some portion of their claims remained undisputed.
History of Section 303(b)
Section 303(b)(1) has undergone two revision since it was enacted as part of the Bankruptcy Reform Act of 1978. When first enacted, it lacked the requirement that a creditor’s claim not be the subject of a bona fide dispute. Congress added that requirement through the Bankruptcy Amendments and Federal Judgeship Act of 1984.
Unfortunately, the 1984 amendment did not define “bona fide dispute,” leading to disagreement amongst courts as to the interpretation of the applicable standard. Courts “more or less settled on finding a bona fide dispute when there is either a genuine issue of material fact that bears upon the debtor’s liability or a meritorious contention as to the application of law to undisputed facts.” See Fustolo v. 50 Thomas Patton Drive, LLC (In re Fustolo), 816 F.3d 1, 6-7 (1st Cir. 2016) (quoting In re BDC 56 LLC, 330 F.3d 111, 117 (2d Cir. 2003)). But, some courts also recognized that a bona fide dispute as to a portion of a petitioning creditor’s claim would not disqualify the creditor under section 303(b)(1) if a portion of that claim was undisputed. See, e.g., IBM Credit Corp. v. Compuhouse Sys., Inc., 179 B.R. 474, 479 (W.D. Pa. 1995), aff’d, 85 F.3d 612 (3d Cir. 1996).
Then, in 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) amended section 303(b)(1) by adding the term “as to liability or amount” after “bona fide dispute.” This amendment led some courts to conclude that the statute now strips a creditor of standing if there is a bona fide dispute as to any amount of its claim, no matter how small. See, e.g., Montana Dep’t of Revenue v. Blixseth, 581 B.R. 882, 903 (D. Nev. 2017), appeal docketed, No. 15064 (9th Cir. Jan 16, 2018). Other courts, however, have viewed the 2005 amendment as simply clarifying prior legislative intent, though not affecting the pre-BAPCPA operation of section 303(b)(1). See, e.g., In re Miller, 489 B.R. 74, 82 (Bankr. E.D. Tenn. 2013); In re Tucker, No. 5:09-bk-914, 2010 WL 4823917, at *6 (Bankr. N.D. W. Va. Nov. 22, 2010).
The Bankruptcy Court in General Aeronautics agreed with the line of cases that interpreted BAPCPA’s amendment to section 303(b)(1) as permitting creditors to have standing provided a portion of their claims are undisputed.
The Court first reasoned that when Congress enacted the BAPCPA amendment, it was presumed to act with knowledge of the existing law and judicial concepts. See In re VistaCare Grp., LLC, 678 F.3d 218, 226 (3d Cir. 2012). Indeed, the Supreme Court has stated that “[p]re-BAPCPA bankruptcy practice is telling because [courts] ‘will not read the Bankruptcy Code to erode past bankruptcy practice absent clear indication that Congress intended such a departure.'” Hamilton v. Lanning, 560 U.S. 505, 517 (2010) (internal citation omitted) (emphasis added).
The Court found that BAPCPA’s amendment did not alter the operation of section 303(b)(1), which, per the 1984 amendment, already struck a balance between the interests of petitioning creditors to have access to bankruptcy courts and the interests of debtors to avoid being bullied into bankruptcy by creditors with questionable claims. According to the Court, to view the BAPCPA amendment as disqualifying a creditor where any amount of its claim is disputed would shift the balance struck in 1984, but there was no clear indication that Congress intended such departure from pre-BAPCPA practice. See In re DemirCo Holdings, Inc., No. 06-70122, 2006 WL 1663237, at *3 (Bankr. C.D. Ill. June 9, 2006) (finding dearth of legislative history to clearly indicate drastic shift in practice); 2 Collier on Bankruptcy ¶ 303.11.
In addition, the Court found that viewing the BAPCPA amendment as disqualifying a creditor with a partially disputed claim would lead to absurd results; “so bizarre that Congress could not have intended it.” See Robbins v. Chronister, 435 F.3d 1238, 1241 (10th Cir. 2006). The Court reasoned that a strict plain meaning interpretation of section 303(b)(1) would unjustly disqualify many petitioning creditors who have inconsequential portions of their claims disputed.
The Court then turned to the standard for determining a “bona fide dispute,” which in the 10th Circuit means an “objective basis for either a factual or legal dispute as to the validity of [the] debt.” Bartmann v. Maverick Tube Corp., 853 F.2d 1540, 1544 (10th Cir. 1988).
In General Aeronautics, the preponderance of the evidence revealed that, based on promises made by the officers of GAC, the non-executive employees were entitled to claims for deferred compensation and bonuses. The fact that several of those petitioning creditors had already been awarded certain sums by the Utah Labor Commission did not result in a waiver of their deficiency claims against GAC.
With respect to separate claims for unpaid compensation and loans by former executives, the Court found that, at least, one of the executives held an undisputed claim of $69,099.95 for unpaid loans, but the remaining executives’ claims were subject to bona fide dispute–or, at least, it was unnecessary to determine their status.
GAC argued that many of the petitioning creditors’ claims for unpaid compensation and loans were subject to dispute because GAC’s board had not previously approved them. But, the Court found that the board had ceded such authority to its officers, who, in fact, approved certain undisputed amounts claimed by the petitioning creditors.
The last petitioning was the landlord. GAC argued that the landlord’s claim was disputed because GAC never entered into or assumed the lease with the landlord and GAC’s predecessor continued to occupy the leased space. The Court found, however, that GAC had already acknowledged a portion of the liability for rent in correspondence with the landlord and its own accounts payable report.
Some of the petitioning creditors argued that GAC had assumed certain liabilities that were incurred by GAC’s predecessor, given that GAC had set up its own payment plan for such debt. But, the Court rejected this argument, finding that GAC had not expressly assumed such liabilities and thus such debt would not be counted for purposes of section 303(b).
The Court ultimately held that the landlord, five former non-executives and one executive had partially undisputed claims, in excess of $330,000.00, well-above the statutory limit to confer standing under section 303(b).
The Court then went on to find that GAC was not paying its debts as they come due, because, even though GAC was paying its current monthly expenses, (a) it had substantial, years-old debts that remained unpaid, (b) its remaining cash reserve was dwindling quickly and (c) no new revenues were coming in the door. Under the totality of circumstances, that petitioning creditors demonstrated that the requirements under section 303(h)(1) had been met.
The General Aeronautics opinion appears to reach the appropriate result under the circumstances. When an insolvent company amasses so much debt, it is sometimes hard simply to sweep that liability under the rug. In GAC’s case, nineteen current and former employees, a landlord and numerous third parties had waited many years to get paid. The Bankruptcy Court could not ignore the existence of such significant liabilities, even though GAC argued that not all of it was owed.
The Court cited an example in the opinion of an absurd result, based on a strict plain meaning interpretation of the statute. Assume a creditor is owed $100,000 and $100 of it is in dispute. It would be unjust to prevent such creditor from availing itself of section 303 of the Code, especially when Congress has not provided a clear indication that it intended such result. While the facts in General Aeronautics were not quite as bad, they did provide enough credence for the Court to hold that creditors with partially disputed claims still qualify to be petitioning creditors under section 303(b)(1) of the Bankruptcy Code.