Involuntary Bankruptcy Is Even Riskier Than You Thought

We all know that per 11 U.S.C. § 303(i), when an involuntary bankruptcy petition is unsuccessful, the court may grant judgment against the petitioning creditors for attorney fees, and may also award damages and punitive damages if the petition was filed in bad faith. The Bankruptcy Appellate Panel has sharpened those tools in a recent decision: In re Macke International Trade, Inc., 2007 WL 1845519 (Bankr. App. 9th Cir. June 8, 2007).

Macke manufactured pet care products. The single petitioning creditor, one Lawrence Weschler, was a competitor of the debtor who also happened to be a patent lawyer. Weschler won a $650,000 infringement judgment, then on appeal. The other two major creditors were lawyers who had represented Macke in the patent litigation. During the pendency of the appeal, the debtor made a general assignment for the benefit of creditors. The assignee liquidated Macke’s assets for $10,500. Weschler decided not to participate in the assignment, and did not file a claim.

Six months after the assignment, Weschler filed an involuntary bankruptcy petition against Macke. Macke moved to dismiss under the abstention provision, 11 U.S.C. §305(a), on the grounds that “the interests of creditors and the debtor would be better served” by dismissal (quoting the statute). The Bankruptcy Court agreed and decided to abstain, a decision which is “not reviewable by appeal or otherwise” under 11 U.S.C. § 305(c). That’s where the fun really began.

The Bankruptcy Court, having decided to abstain, did not abstain from awarding attorney fees against Weschler, relying on the language in section 303(a) which allows such an award “if the court dismisses a petition under this section other than on consent of all petitioners and the debtor. . . .”

To add insult to injury, the Court then ruled that the attorney fee award could not be offset against Macke’s indebtedness on the judgment. In so holding, the BAP followed the reasoning of In re Schiliro, 72 B.R. 147 (Bankr.E.D.Pa.1987), and quoted that decision as follows:

If the petitioning creditor could suffer no other recourse except a reduction in his probably-uncollectible judgment as a penalty for requiring a debtor to defend an unjustified case, and Congress has specifically stated should result in such a penalty, the disincentive built into the system to discourage such actions would evaporate. The rule sought by [the petitioning creditor] would surely be a boon to creditors who seek to wear down to submission small debtors such as the Debtor here.

To summarize: A creditor can file a completely meritorious involuntary bankruptcy petition, but the bankruptcy court can exercise its non-reviewable discretion to decline jurisdiction over the case. On its way out the door, however, the bankruptcy court can award attorney fees against that creditor for taking the wrong position on whether the “interest of creditors and the debtor” would be better served by bankruptcy. And the bankruptcy court can override the law of setoff by concluding on public policy grounds that the debt for attorney fees has greater dignity than a judgment for damages rendered by a United States District Court. Ouch!

Copyright Dean T. Kirby 2007. All rights reserved.