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Dismissal of Involuntary Petition Can You Buy Your Way Out

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As a follow-up to the October 2001 Practice and Procedure article, "Exceptions to Involuntary Petition Requirements: Are you Pushing Your Luck," additional issues regarding the filing and potential dismissal of an involuntary bankruptcy merit discussion. After all, upon the filing of an involuntary petition, the alleged debtor, as such are called during the period between the filing of an involuntary petition and the entry of an order of relief, will typically want to dismiss the involuntary petition by whatever means necessary, including paying one or more of the petitioning creditor's claims.

In fact, such desperation may cause the alleged debtor to take drastic measures in dealing with its creditors. Such measures may include expending large sums of money to eradicate the problem, seen here as the petitioning creditors. Indeed, the filing of an involuntary petition will often raise a spite fence where one may or may not have previously existed. Such measures are not necessarily successful, as most courts have intervened in such attempts.

Involuntary Petitions Under the Bankruptcy Code

Pursuant to 11 U.S.C. §303, an involuntary bankruptcy case under chapter 7 or 11 may be commenced against an individual or entity that may be a debtor under the chapter under which such case is commenced. Generally, an involuntary case is commenced by the filing of a petition:

  1. by three or more entities, that hold claims that are not contingent or subject to bona fide dispute, if the claims of such entities aggregate at least $10,775 more than the value of any lien on property securing such claims; or
  2. if there are fewer than 12 claim holders, by one or more of such holders that hold in the aggregate at least $10,775 of such claims.
See 11 U.S.C. §303(b).

Section 303 further states that the court shall order relief against the debtor, only if:

  1. the debtor is generally not paying its debts as such debts become due, unless such debts are the subject of a bona fide dispute; or
  2. within 120 days before the petition date, a custodian was appointed or took possession of substantially all of the debtors' property.
See 11 U.S.C. §303(h).

If less than three creditors filed the involuntary petition against an alleged debtor with 12 creditors, dismissal would be proper. One exception was discussed in the October 2001 ABI Journal in connection with the "special circumstances" exception recognized by many courts. When such special circumstances do not exist, however, the lack of three petitioning creditors results in a dismissal of the involuntary petition.

Many alleged debtors have attempted to create the grounds for dismissal by reducing the number of petitioning creditors. Theoretically, the number of petitioning creditors could be reduced by paying the petitioning creditor in full. Thus, all the alleged debtor need do is make payment in full to the smallest petitioning creditor.

As stated below, however, such means are not accepted by courts as a valid ground for dismissing an involuntary bankruptcy due to the policy considerations involved.

Payment of Petitioning Creditors' Claims

Pursuant to §303(h), an alleged debtor may contest the entry of an order for relief due to the filing of an involuntary petition. If less than three petitioning creditors exist, then the requirements of §303(b)(1) are not satisfied (assuming that the alleged debtor has less than 12 creditors). Further, if the alleged debtor paid off each of the petitioning creditors, then no party would exist to contest a motion to dismiss or the alleged debtor's evidence as to whether it is generally paying its debts as they become due.

Both strategies assume, however, that no additional creditors join in the involuntary petition as contemplated by §303(c). Such joinder would undermine the alleged debtor's attempts to subvert the involuntary filing and/or require additional payments to petitioning creditors. More importantly, many courts have held that an alleged debtor cannot avoid an involuntary bankruptcy petition by merely paying creditors. See In re All Media Properties Inc., 5 B.R. 126 (S.D. Tex. 1980); In re Faberge Restaurant of Florida Inc., 222 B.R. 385 (S.D. Fla. 1997).

In All Media, the alleged debtor paid one of its three petitioning creditors in full after the filing of the involuntary petition. The alleged debtor asserted that the paid creditor could no longer be considered a petitioning creditor, thereby defeating §303(b)(1)'s requirements. The court, however, held that satisfaction of a claim after the filing of an involuntary petition does not deprive the court of jurisdiction. All Media, 5 B.R. at 137; citing Reed v. Thornton, 43 F.2d 813 (9th Cir. 1930); In re Gibraltor Amusements Ltd., 187 F.Supp. 931, 937 (E.D.N.Y. 1960), aff'd., 291 F.2d 22 (2d Cir. 1961), cert. den., 368 U.S. 925, 82 S.Ct. 360, 7 L.Ed.2d 190 (1961). In fact, not only did All Media hold that the court did not lose jurisdiction, but that the petitioning creditor also did not lose its status as a petitioning creditor. All Media, 5 B.R. at 137.

Similarly, in Faberge, two petitioning creditors received payment after the petition date, and the alleged debtor moved to dismiss because of the lack of standing of those petitioning creditors. In response, the court held that "policy reasons, and other considerations, dictate that the post-petition payments will not deprive the court of jurisdiction or require the dismissal of the petition." Faberge, 222 B.R. at 388; citing Reed v. Thorton, 43 F.2d 813 (9th Cir. 1930); Matter of Sjostedt, 57 B.R. 117, 120 (Bankr. M.D. Fla. 1986); In re Claxton, 21 B.R. 905 (Bankr. E.D. Va. 1982); In re Carvalho Industries Inc., 68 B.R. 254 (Bankr. Ore. 1986). Based thereon, the court refused to dismiss the alleged debtor's involuntary bankruptcy. Thus, despite what would seem an otherwise logical inference, an alleged debtor cannot avoid the consequences of the filing of an involuntary petition by merely making payment to the petitioning creditors.

None of these cases, however, dealt with circumstances where the alleged debtor paid all of the petitioning creditors in full. Payment of all petitioning creditors would lead, theoretically, to a lack of any party to contest the alleged debtor's assertions that its debts were paid as they became due. Because of the lack of controverting evidence, it seems possible to defeat an involuntary petition by paying all petitioning creditors' claims, assuming again that no joinder occurs.

Conclusion

The desire to derail an involuntary bankruptcy petition is a natural reaction to an extreme remedy at law. Derailing an involuntary bankruptcy, however, is not as easy as one might first assume. In fact, policy reasons dictate the result based on the concept of protecting other creditors of the estate. The old adage remains true: Filing bankruptcy is very easy, but exiting bankruptcy can be very difficult.

Journal Date: 
Saturday, December 1, 2001

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