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As part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Congress made certain modifications to � 303 of the Bankruptcy Code, 11 U.S.C. 303. Section 303 sets forth the requirements that petitioners must satisfy in order to commence involuntary bankruptcy proceedings and for the subject entity to be adjudged a debtor for purposes of such proceedings. This article considers the extent, if any, to which the modifications to � 303 change existing law, as applied by the courts. Under the prior version, � 303(b)(1) provided in pertinent part that an involuntary case is commenced by the filing of a petition by three or more entities, each of which is a holder of an unsecured claim against such person “that is not contingent as to liability or the subject of a bona fide dispute,” if the amount of such claims aggregate the statutory minimum, which is currently $12,300. (If the putative debtor has fewer than 12 creditors, excluding employees or insiders of the putative debtor, one person may file.) The new law changed � 303(b)(1) by adding “as to liability or amount” after “bona fide dispute.” The prior version of � 303(h)(1) provided that, if an alleged debtor contests the filing of the involuntary petition under � 303(b)(1), the court, after trial, shall order relief against the debtor only if it is generally not paying its debts as they become due “unless such debts are the subject of a bona fide dispute.” Similar to � 303(b)(1), the new law changes � 303(h)(1) by adding “as to liability or amount” after “bona fide dispute.” Retroactive application will not violate Constitution As an initial matter, the new law provides that these amendments shall take effect upon enactment and shall apply with respect to cases commenced “before, on and after such date.” In other words, the amendments are supposed to be applied retroactively. Retroactivity instinctively raises questions of fairness; however, the U.S. Supreme Court has held that application of an intervening statute that confers or ousts jurisdiction or changes procedural rules in suits arising before its enactment does not raise constitutional concerns. Because � 303 is considered a jurisdictional statute, coupled with the general principles that bankruptcy relief is a privilege and not a constitutional right, it is clear that the retroactive application of these amendments, even if they alter existing law, will not violate the Constitution. See In re BDC 56 LLC, 330 F.3d 111 (2d Cir. 2003). Courts have distilled three substantive requirements for an involuntary petition to be valid under � 303: There must be at least three petitioning creditors (only one if the debtor has fewer than 12 creditors); each petitioning creditor must hold unsecured claims against the debtor not subject to bona fide dispute and totaling at least $12,300; and the debtor is generally not paying debts as they come due. In re Focus Media Inc., 378 F.3d 916 (9th Cir. 2004); In re Amanat, 321 B.R. 30 (Bankr. S.D.N.Y. 2005). While the requirement to have at least three petitioning creditors is straightforward enough, creditors are often reluctant to join in the filing of such a petition because, if the involuntary petition is dismissed, they could be facing severe consequences under � 303(i). Further, there is the risk that a debtor could successfully show that related entities should be deemed to be one and the same creditor. Also, creditors pushing for an involuntary filing should be mindful of the prohibition in Rule 1003 of the Federal Rules of Bankruptcy Procedure of assigning claims for the purpose of commencing an involuntary case. See, e.g., Focus Media, supra. The term “bona fide dispute” is not defined in the Bankruptcy Code. While courts have articulated different standards, they have settled on one in recent years requiring that there be “an objective basis for either a factual or a legal dispute as to the validity of the debt.” In other words, a bona fide dispute exists only when “there are substantial factual or legal questions that bear upon the debtor’s liability.” In re Byrd, 357 F.3d 433 (4th Cir. 2004). Under this standard, the petitioning creditors bear the burden of a prima facie showing that no bona fide dispute exists and, upon that showing, the burden shifts to the debtor to demonstrate that there is such a dispute. Because the filing of an involuntary petition may, under appropriate circumstances, be part of valid collection efforts, courts have often disagreed on the preclusive effect that state court proceedings should have on the question of whether a dispute satisfies this standard. Some lower courts have taken the position that unstayed judgments cannot be the subject of a bona fide dispute. However, such a “hard and fast” rule has recently been rejected in favor of a more flexible approach that allows a court to consider practical issues, such as whether a debtor did not contest its liability because it could not afford to mount a defense, as well as the underlying factual and legal merits of the claim. In doing so, the court is not deciding the ultimate issues, but merely assessing their genuineness. Debtors have also attacked involuntary petitions by attempting to create factual disputes relating to the amount of the petitioning creditors’ claims by asserting some right of offset. However, courts have consistently held that any such dispute must, in the end, potentially bring the undisputed amount of such claims below the $12,300 statutory threshold. Also, in recent cases, courts have analogized debtors’ offset claims to those of recoupment, meaning that the claims must arise out of the same transaction. In so doing, courts have also consistently held that a dispute as to amount is bona fide only if it does not arise from a wholly separate transaction, and netting out the debtor’s claims could take the petitioning creditors’ claims below � 303′s threshold. In re Focus Media, supra. Assuming that the requirements of � 303(b)(1) are met, the court must also determine whether the debtor is generally paying its debts as they come due under � 303(h)(1). In making this determination, courts consider the number of claims that the debtor has not paid, the amounts of these unpaid claims, the materiality of the nonpayments and the debtor’s overall financial condition and affairs. Other courts have considered the “totality of the circumstances.” Compare In re Amanat, supra, with In re Focus Media, supra. Regardless, the determination is a fact-intensive analysis that will be made on a case-by-case basis. Like � 303(b)(1), � 303(h)(1) excludes debts that are the subject of a bona fide dispute from consideration. Interestingly, the bona fide-dispute language was added in 1984 as a form of debtor protection. It was added to correct some courts’ interpretation of � 303(h)(1) as allowing the granting of involuntary relief even when the debtor has a good-faith dispute. This interpretation led creditors to use the Bankruptcy Code as a club against debtors who had bona fide questions about their liability, but who would rather pay up than suffer the stigma of involuntary bankruptcy proceedings. In re Century/ML Cable Venture, 294 B.R. 9 (Bankr. S.D.N.Y. 2003). Impact of amendments on existing law In reviewing the relatively sparse number of cases that have dealt with � 303(b)(1) and (h)(1), the disputes in contested involuntary proceedings have evolved to include not only issues of liability but also questions of amount. A review of the cases also shows that these issues are disjunctive, as opposed to conjunctive. As a result, if a debtor prevails on either issue, the bankruptcy petition must be dismissed and a motion for an award under � 303(i) is certain to follow. However, an argument can also be made that the language of the amendments is not entirely consistent with pre-existing law. For instance, in reviewing the language “liability or amount,” any dispute over liability will most likely involve a dispute over the entire amount of debt at issue. Thus, in order not to be superfluous, the reference to amount indicates something less than the whole amount. But the language does not make any reference to the statutory threshold. A debtor can therefore argue that, under the new statute, the dispute as to the amount of a claim does not have to reach the threshold of $12,300 to successfully defeat a petitioning creditor’s claim. In order to avoid this dispute, a creditor could obtain, before filing, an acknowledgment, be it in an e-mail, letter or some other written form, from the debtor regarding its liability for, and the amount of, the claim. Of course, it will be easier to obtain this statement if the creditor is attempting to work with the debtor, as opposed to being openly hostile to it. Such a statement can then be introduced to refute any argument by the debtor to the contrary and could also diminish the blow if an involuntary petition is subsequently dismissed. If an involuntary petition is dismissed other than on consent of all petitioners and the debtor, and if the debtor does not waive its rights, a court may award the debtor attorney fees and costs or, if the involuntary petition is filed in bad faith, compensatory and punitive damages under � 303(i). Courts can apply these penalties with full force to petitioners subsequently joining in the involuntary petition. See, e.g., In re ELRS Loss Mitigation LLC, 2005 Bankr. Lexis 1048 (Bankr. N.D. Okla. June 6, 2005). Thus, given the potential liability if an involuntary petition is dismissed, creditors should always proceed with caution when considering filing or joining in filing an involuntary petition. Craig Rankin is a partner at Los Angeles-based bankruptcy boutique Levene, Neale, Bender, Rankin & Brill. Christopher Alliotts is of counsel to the Menlo Park, Calif., office of Los Angeles-based SulmeyerKupetz.

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