Meeting §303(b) Requirements in Creditor Involuntary Relief Petitions

by Lesley Anne Hawes March/April 2009

The en banc decision in Trusted Media highlights the significant practical and legal implications of a ruling that makes a determination that the requirements of §303(b) are properly met — a prerequisite to subject matter jurisdiction, as the Fifth and Second Circuits hold. Creditors filing an involuntary petition for relief against a debtor must “get it right” or risk substantial uncertainty as to the validity of orders and activities in the case.

The Court of Appeals for the Eleventh Circuit in an en banc decision in the case In re Trusted Media Holdings, LLC, 2008 WL 5069824 (11th Cir. 2008), has ruled that satisfying the statutory requirements for filing an involuntary petition in bankruptcy is not a prerequisite for the bankruptcy court to have subject matter jurisdiction over an involuntary bankruptcy case. The decision is consistent with a reported decision of the Ninth Circuit, but conflicts with reported decisions of the Fifth and Second Circuit, creating a split among the circuits on a fundamental issue of bankruptcy procedure.

Lack of subject matter jurisdiction is a claim that is not waivable and which may be raised at any point in a case. Where a court lacks subject matter jurisdiction over the case, the court lacks authority to act and the case must be dismissed. The facts and procedural history of the Trusted Media Holdings case demonstrate why the determination of whether meeting the statutory criteria for an involuntary petition is jurisdictional has major implications for the parties to a proceeding and why this split among the circuits cries out for resolution.

Statutory Framework
Title 28 of the U.S. Code sets forth the basis upon which bankruptcy courts exercise jurisdiction. Under §1334, jurisdiction over cases under Title 11 of the U.S. Code (the Bankruptcy Code) is granted to the district courts. The bankruptcy courts are units of the district courts, and the district courts are authorized to refer cases under Title 11 and proceedings “arising in” or “arising under” Title 11 to the bankruptcy courts. [See 28 U.S.C. §151, §157(a)].

Most bankruptcy cases are commenced by the filing of a voluntary or joint petition for relief under §301 or §302, respectively, of the Bankruptcy Code. Section 303 of the Bankruptcy Code governs the commencement of a case by filing an involuntary petition. Section 303(b) states that an involuntary case is commenced by the filing of a petition by creditors who meet the following qualifications: 
1.) Where there are at least 12 creditors holding claims against the debtor that are not contingent or subject to a bona fide “dispute as to liability or amount,” at least three must join in the petition; 2.) If there are less than 12 noncontingent claims not subject to a good faith dispute, the petition may be filed by one creditor holding such a noncontingent, undisputed claim. Any creditor who could have qualified as a petitioning creditor may subsequently join in an involuntary petition after the involuntary petition is filed and before the petition is dismissed.

Facts of the Trusted Media Case
The factual context in which the Trusted Media case arises illustrates the potentially dire consequences to the creditors and other interested parties in an involuntary case if the requirements of Bankruptcy Code §303(b) are considered jurisdictional and it is subsequently determined that those requirements were not met when the petition was filed. In Trusted Media, the debtor was subject to a pending state court receivership when an involuntary petition under Chapter 7 of the Bankruptcy Code was filed by a single creditor, Morrison. Morrison asserted in the petition that its claim was noncontingent and undisputed and that the debtor had less than 12 holders of noncontingent, undisputed claims such that Morrison properly qualified as the petitioning creditor for the involuntary petition.

The debtor did not contest the petition and an order for relief was entered. A Chapter 7 Trustee was appointed who began liquidating assets and otherwise administering the case. Two years later, one of the debtor’s officers filed a motion to dismiss the petition. For the first time, that motion asserted that the Morrison claim was disputed, that the petition was defective because there were more than 12 noncontingent, undisputed claims against the debtor, that at least three petitioning creditors were required in order for the case to have been properly commenced under the statutory criteria of Bankruptcy Code §303(b) and that the case therefore had to be dismissed for failure to meet the requirements of §303(b) of the Bankruptcy Code. The bankruptcy court denied the motion to dismiss, and the debtor’s officer who brought the motion did not appeal the order denying the dismissal motion.

The Chapter 7 trustee continued to administer the case and subsequently reached a settlement agreement regarding the amount of the Morrison claim as well as settlements with four other creditors on their claims. The debtor’s office then claimed that the fact the Morrison claim was disputed by the Chapter 7 trustee and was resolved by settlement agreement proved that Morrison’s claim did not meet the requirement of Bankruptcy Code §303(b) that the petitioning creditor’s claim be noncontingent and undisputed. Therefore, two years after the first motion to dismiss (four years after the involuntary petition had initially been filed), the debtor’s officer brought another motion to dismiss, asserting the same defects alleged in his first motion to dismiss but also contending in the new motion that the failure to meet the requirements of §303(b) meant the bankruptcy court lacked subject matter jurisdiction over the case. The new motion to dismiss argued that meeting the requirements of §303(b) were jurisdictional prerequisites to the bankruptcy court having the ability to hear and determine the bankruptcy case.

The bankruptcy court denied the second motion to dismiss, and the district court affirmed. The officer who moved to dismiss the involuntary petition then appealed to the Court of Appeals for the Eleventh Circuit. The officer who moved to dismiss conceded that he may have waived his arguments by never contesting the involuntary petition, not appealing the first order denying his motion to dismiss, and not raising the alleged defects in the petition sooner. However, he argued that because the defects go to the subject matter jurisdiction of the bankruptcy court over the case, waiver does not apply: the claim that the involuntary petition was deficient under §303(b) is not a waivable claim, may be asserted at any time, and if the court lacks subject matter jurisdiction, the court has no authority to hear or determine the matter on the merits.

In the initial hearing in the Court of Appeals, the three-judge panel of the Eleventh Circuit reluctantly agreed that the motion to dismiss should have been granted, holding that the court was bound to follow a prior published Fifth Circuit decision in the case In re All Media Properties, Inc., 646 F. 2d 193 (5th Cir. 1981), which held that the requirements set forth in Bankruptcy Code §303(b) for an involuntary petition had to be met in order to create subject matter jurisdiction over the case in the bankruptcy court. (The Eleventh Circuit, whose jurisdiction was carved out of the Fifth Circuit in 1981, has determined that all Fifth Circuit cases decided prior to October 1, 1981 constitute binding precedent on the Eleventh Circuit Court of Appeals and courts within that circuit.) As a result, under the Fifth Circuit All Media decision, proof that the requirements of an involuntary petition were not met mandated dismissal of the case despite the passage of more than four years since the petition was originally filed.

The Fifth Circuit’s holding in All Media Properties conflicts with a subsequent published decision of the Ninth Circuit in the case In re Rubin, 769 F. 2d 611 (9th Cir. 1985) and a number of other lower court decisions from other circuits. Given the conflicting authority, the Eleventh Circuit agreed to a rehearing of the Trusted Media case by all members of the Eleventh Circuit bench (en banc) to re-examine the Fifth Circuit precedent.

The Eleventh Circuit addressed the split in the circuits between the Ninth Circuit’s decision in Rubin on one hand, and the Second Circuit’s on the other, noting that most commentators and lower courts agree with the result in Rubin, finding that subject matter jurisdiction over an involuntary case is conferred by the general bankruptcy jurisdictional statutes in Title 28 rather than the petition requirements under §303(b). Based on its independent analysis of the statute, Bankruptcy Code §303, and other authority, the Eleventh Circuit en banc concluded that the statutory requirements for commencement of an involuntary bankruptcy case are not required to be met to confer subject matter jurisdiction on the bankruptcy court before which the involuntary petition is pending and that to the extent All Media concluded subject matter jurisdiction does not exist if one or more of the requirements of §303(b) is not met, the Rubin case was wrongly decided.

Implications of the Case
The en banc decision in Trusted Media highlights the significant practical and legal implications of a ruling that makes a determination that the requirements of §303(b) are properly met — a prerequisite to subject matter jurisdiction, as the Fifth and Second Circuits hold. Creditors filing an involuntary petition for relief against a debtor must “get it right” or risk substantial uncertainty as to the validity of orders and activities in the case. Often as a practical matter, creditors that intend to file an involuntary petition may not want to broadly publicize their intentions until the petition is filed. For cases in the Fifth and Second Circuits, given the provisions of §303(c), which allow other qualified creditors to join the petition after it is filed and before it is dismissed “with the same effect as if such joining creditor were a petitioning creditor under §(b),” soliciting additional creditors to join after the initial filing may be even more important to ensure that sufficient qualified creditors have supported the petition to eliminate any doubt as to the sufficiency of the filing and the bankruptcy court’s jurisdiction.

Further, as the initial ruling by the three-judge panel of the Eleventh Circuit in Trusted Media illustrates, creditors may be at risk if they rely on a debtor’s failure to respond to the involuntary petition or failure to take steps to dismiss the petition as assurance the case is properly commenced regardless of the length of time the case has been administered. The best assurance as to the validity of the case in those jurisdictions that do not follow Rubin and Trusted Media will be a careful and prompt review of the books and records of the debtor after the involuntary is filed to determine the claims against the entity and ensure that there are sufficient petitioning or joining creditors with clear, undisputed claims that are noncontingent to ensure the petition cannot later be dismissed.

Lesley Anne HawesLesley Anne Hawes, a partner in the Los Angeles office of McKenna Long & Aldridge, LLP, specializes in the representation of secured and unsecured creditors in bankruptcy proceedings and in the representation of federal equity receivers appointed in civil enforcement actions by federal agencies such as the Federal Trade Commission and Securities and Exchange Commission. Hawes is a regular contributor to the Monitor and other legal journals, and she has lectured for the National Business Institute and other organizations. She graduated Order of the Coif from University of Southern California law school and earned her undergraduate degree in political science magna cum laude from University of Southern California.

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