The Bankruptcy Code clearly permits creditors to initiate an involuntary bankruptcy filing, and the Official Forms contain the simple paperwork to start the process. 11 U.S.C. §303. However, the risks of being accused by the putative debtor of a “bad faith” filing are probably better than 50/50, depending on what has been going on leading up to the filing. It is not nearly as routine and simple as it may appear.
A string of recent decisions at the Circuit Court level prove that the risk may well outweigh the “reward” of filing an involuntary petition. The Sixth Circuit has long had a strong case which dissuades the filing of involuntary cases, since the Sixth Circuit upheld over $4 million of compensatory damages, $2 million of punitive damages and close to $315,000 of attorneys’ fees incurred by the alleged putative debtor in fighting for the dismissal of the case. See In re John Richards Homes Building Co, LLC, 439 F.3d 248 (6th Cir. 2006). (Unfortunately, these particular parties chased each other through multiple courts for years in appeals and attempts to collect against each other). Most litigants can’t afford this kind of legal exercise.
Recent additional courts have reiterated the Sixth Circuit’s wisdom regarding the risks of serious sanctions for bad faith or other “abusive” filings, and/or the amount of litigation that an involuntary petition can create, all being very fact-specific (and thus very expensive to litigate). See, e.g., Matter of 8Speed8, Inc., 921 F.3d 1193 (9th Cir. 2019) (denying damages because only putative debtor had standing to seek, not 50% equity holder. Noting that award of damages is discretionary and is intended to alleviate consequences such as “loss of credit standing, inability to transfer assets and carry on business affairs, and public embarrassment.” Dissent noted that involuntary filing is “a drastic course of action that carries significant consequences”); In re Reyes-Colon, 922 F3d 13 (1st Cir 2019)(affirming dismissal of an involuntary petition against a plastic surgeon – following over twelve years of litigation! – over whether the requisite number of petitioning creditors existed); In re Murray, 900 F3d 53 (2d Cir 2018)(filing of involuntary is not intended to address “special grievances” particular to certain creditors only, vs. being an avenue of relief for the benefit of the overall creditor body).
There is much case law on this topic, and both creditors and putative debtors are advised that this area is ripe for contentious and costly litigation, the result of which may be either a trip through the bankruptcy process, or a trip down the lane towards damages and legal fees. Creditors Beware!
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