In In Re: HH Technology Corp., a creditor filed a motion seeking to join an involuntary petition nearly eight weeks after the Bankruptcy Court judge’s initial joinder deadline, arguing that there was “good cause” to allow its late request.
Being allowed to join was critical, as the involuntary petition needed at least three creditors attached to it to proceed under §303(b)(1) of the Bankruptcy Code, and the late-filing creditor stood to be the third.
In challenging the dismissal of their involuntary bankruptcy petition, the three creditors argued that §303(c) “creates a statutory right to join an involuntary petition at any time prior to dismissal or grant of relief.”
But the appellees countered that their opponents were ignoring Bankruptcy Rules 1003(b) and 1013(a), as well as the Bankruptcy Court’s inherent authority to set deadlines.
They urged the BAP to adopt the holding of the 6th Circuit case In re DSC, Ltd. that §303(c) “merely sets an absolute outside limit on the time within which certain qualifying creditors may join an involuntary petition … [but] does not prohibit a court from setting an earlier deadline, based upon its case management authority.”
The BAP agreed, ruling first that establishing the joinder deadline was within the Bankruptcy Court’s “formidable case-management authority” and the “great latitude” judges have in exercising that authority.
“In addition, DSC’s approach best harmonizes the tension between §303(c) (permitting joinder ‘before the case is dismissed or relief is ordered’) and Bankruptcy Rule 1013(a) (requiring a court to ‘determine the issues of a contested petition at the earliest practicable time and forthwith enter an order for relief [or] dismiss the petition’) — a goal which finds support in well-established rules of statutory construction,” Judge Peter G. Cary of Maine wrote for the panel.
The BAP went on to rule that the Bankruptcy Court judge had properly denied the untimely joinder motion considering all the circumstances, including the late-filing creditor’s awareness of the joinder deadline and the fact that it had previously consented to the debtor using an assignment for the benefit of creditors to wind up its business affairs.
The 30-page decision is Lawyers Weekly No. 03-005-24.
Judicial autonomy preserved
The decision is an important one, reaffirming the autonomy of the bankruptcy courts and their ability to fairly and efficiently hear involuntary cases, said one of the appellees’ attorneys, Francis C. Morrissey of Braintree.
“Not allowing bankruptcy courts to manage their own dockets is a recipe for chaos in the bankruptcy courts,” he said.
Morrissey noted that the case arose from a Polish company trying to enforce a multi-million-dollar foreign default judgment.
“The law is very, very clear: Bankruptcy courts are not collection agents,” he said. “Bankruptcy is not there to be an adjunct to a judgment creditor’s debt-collection activities. Involuntary cases aren’t to be used to prosecute two-party disputes.”
The appellants’ attorney, Ilyas J. Rona of Boston, said his clients will likely seek further review from the 1st Circuit.
Rona said the statutory language allowing creditors an unfettered right to join an involuntary petition “is pretty straightforward and clear.”
“In this case, there were three petitioning creditors before the start of a trial, and it was a three-day trial, which consumed a lot of party resources and obviously a lot of the judge’s time,” Rona said. “We think that, consistent with the intent of the statute, the trial could have been obviated once a third creditor threw its hat into the ring.”
He added that the 1st Circuit may want to supply guidance on how a party pleads its way through an involuntary petition, given that transfers can disqualify creditors, and it is an open question as to whether defenses to such disqualifications are even to be considered in weighing whether an involuntary petition should be dismissed.
“Our position is that those defenses aren’t to be considered,” he said.
Rona said it is understandable for a bankruptcy judge to want to use deadlines to manage her docket.
But here, allowing the third creditor to join would have obviated a trial on the “minutiae” of whether there were more than 11 creditors in the case overall, he said.
If you lose a reasonable opportunity, you may have made your own bed and failed to sleep in it.
“I don’t think it would upset anything, and I don’t think there was any prejudice to any parties,” he said.
But Boston bankruptcy attorney Richard N. Gottlieb agreed with the BAP’s decision that setting a deadline struck a proper balance between what might otherwise be conflicting mandates in the bankruptcy rules.
The creditor in HH Technology had been given a “reasonable opportunity” to join the petition, he noted.
“If you lose a reasonable opportunity, you may have made your own bed and failed to sleep in it,” Gottlieb said.
Needham bankruptcy attorney Adam J. Ruttenberg agreed.
“You cannot sit on your rights,” he said. “You cannot assume you can do it later.”
Ruttenberg said the BAP also got it “exactly right” in terms of how to consider defenses to claims that preferential transfers should disqualify creditors. Many creditors will have received payments within the 90-day period before the petition was filed that are subject to “easy defenses,” such as the “ordinary course of business” defense or “new value” defense, he noted.
Given the evidence that one of the principals of the alleged debtor had started up an identical business, Gottlieb wondered whether it might have been more prudent for the creditor to have asserted claims against the new company.
Unsuccessful involuntary bankruptcy petitioners put themselves on the hook, jointly and severally, for the debtor’s legal fees and could also be assessed punitive damages, if the involuntary petition was deemed to have been filed in bad faith, he noted.
Morrissey confirmed that his clients would indeed be seeking attorneys’ fees, including those incurred in defending against the creditors’ appeal.
“You need to be very, very careful before you file an involuntary petition that there are no other ways to collect on a particular debt,” Gottlieb said.
Late strategy change
In 2010, Polish chemical manufacturer Rokita obtained a foreign default judgment against HHT, an engineering company with offices in Massachusetts and Texas, for over $1 million in compensatory damages and approximately $12 million in lost profits and other damages.
Rokita then sued in Massachusetts federal court to enforce the default judgment. In December 2021, the District Court partially granted Rokita’s motion for judgment on the pleadings for just over $1 million. That same month, HHT ceased operations and elected to use an assignment for the benefit of creditors to wind up its business affairs. After the assignee accepted the assignment, it sent notification to HHT’s creditors.
Rokita did not assent to the assignment and commenced an involuntary Chapter 7 bankruptcy petition against HHT under §303(b)(2).
The assignee filed a motion to dismiss the voluntary petition, which HHT joined. The assignee and HHT argued that HHT had more than 11 creditors, and, therefore, under §303(b)(1), the commencement of the involuntary bankruptcy against HHT was invalid because it lacked three petitioning creditors.
During a status conference on that motion on April 21, 2022, Bankruptcy Court Judge Janet E. Bostwick issued an order warning that the court would not consider any joinder motions filed after May 23, 2022, “absent a showing of good cause,” and Rokita did not object.
A second creditor, Morimatsu, timely joined the involuntary petition. Three days before the May 23 deadline, Rokita requested a 30-day extension, which was denied.
THE ISSUE: Can a bankruptcy court set a deadline for creditors to join an involuntary petition at a point in time earlier than dismissal or grant of relief?
DECISION: Yes (1st Circuit Bankruptcy Appellate Panel)
LAWYERS: Ilyas J. Ronas of Milligan, Rona, Duran & King, Boston (appellants)
D. Ethan Jeffery and Christopher M. Condon, of Murphy & King, Boston; Francis C. Morrissey of Morrissey, Wilson & Zafiropoulos, Braintree (appellees)
Although it had previously consented to the assignment, DFT filed a motion seeking to join the involuntary petition on July 16, 2022, nearly eight weeks after the expiration of the initial joinder deadline.
DFT argued that there was good cause to allow its late request because it had just discovered new information, including that one of HHT’s principals had formed a new entity that appeared to be operating the same business with the same employees at a nearby location.
But on July 18, 2022, Bostwick ruled that DFT had failed to show good cause to join the petition, reasoning that DFT had been represented by counsel, knew about the deadline, and could have sought additional information or sought an extension before it expired.
In post-trial briefings after a two-day hearing on the motion to dismiss, Rokita and Morimatsu argued that, for the purposes of determining creditor numerosity, 10 of the purported creditors should not be counted because of “numerous genuine issues of material fact.” Alternatively, they argued that HHT should bear the burden of proving affirmative defenses to the claim that the disputed creditors had received preferential transfers.
On March 31, 2023, Bostwick entered the dismissal order, explaining that Rokita and Morimatsu had failed to satisfy their burden of establishing that HHT had fewer than 12 eligible creditors.
She further ruled that Rokita and Morimatsu had failed to meet their burden of showing that creditors were ineligible because they were transferees of voidable transfers.
Rokita, Morimatsu and DFT then appealed Bostwick’s dismissal order “and all interlocutory orders that merge into” that final order, including the ones related to the joinder deadline.
Petitioning creditors’ burden
As to the dismissal order, the appellants had raised three challenges, the BAP noted. They argued that, as a rule, bankruptcy courts should not consider affirmative defenses to avoidability in the context of a motion to dismiss an involuntary petition.
Second, even if it were appropriate to consider such defenses generally, HHT’s failure to plead them should have barred the Bankruptcy Court from considering them, the appellants argued.
Finally, they contended that the Bankruptcy Court erred by placing the burden of proving that those defenses were unavailable to certain of the listed creditors on Rokita and Morimatsu, rather than on HHT.
But in the 1st Circuit, once an involuntary debtor answers the petition and files its required list of creditors, the burden of disputing the existence and eligibility of creditors to be counted towards the numerosity requirement “unequivocally shifts to the petitioning creditors,” the BAP noted.
The panel went on to rule that the Bankruptcy Court had appropriately considered defenses to the appellants’ preference claims and had correctly placed on Rokita and Morimatsu the burden of establishing the unavailability of the §547(c) affirmative defenses.
The BAP added that even if the Bankruptcy Court erred in articulating the burden of proof, it was harmless error because the assignee and HHT had met the burden of proving the existence of potential §547 defenses, even if they were not required to do so.
The panel also found that the failure of the assignee and HHT to plead the affirmative defenses to §547 voidability claims was not fatal, in part because the appellants had been late in raising the §547 claims in the first instance.