Guess? Inc. co-founder Georges Marciano failed to persuade a federal appeals court that, because their nearly $100 million in court judgments against him were still under appeal at the time, his former employees had no right to force him into Chapter 11 bankruptcy.

Addressing an issue of first impression under the U.S. Bankruptcy Code, a three-judge panel of the U.S. Court of Appeals for the Ninth Circuit ruled, 2-1, on February 27 that those judgments were not matters of dispute that could have prevented the employees, as creditors, from filing an involuntary bankruptcy petition against Marciano.

"Under California law, these judgments, in the absence of a stay pending appeal, were plainly not contingent as to liability or amount," Judge Andrew Hurwitz wrote. "Rather, the Petitioning Creditors were entitled to immediate payment of those claims in the amounts set by the superior court judgments."

In a dissent, Judge Sandra Ikuta wrote that the decision created a split with the Fourth Circuit by improperly reducing the power of debtors to challenge their creditors.

"By ignoring this case-specific inquiry in favor of a per se rule, the majority has erroneously elevated judicial efficiency above Congress’s clear commands, ignored our own precedent, and created a circuit split," she wrote. "This result is especially worrisome in the context of bankruptcy, where uniformity is sufficiently important that our Constitution authorizes Congress to establish ‘uniform laws on the subject of bankruptcies throughout the United States.’ "

Bradley Brook of the Law Offices of Bradley E. Brook in Los Angeles, who represents the employees, called the majority ruling "well-founded"—"truly, the only way that the matter could have come out if we’re going to be consistent with the principles and objectives of what bankruptcy is supposed to be about."

Marciano’s attorney, Daniel McCarthy, a partner at Hill, Farrer & Burrill in Los Angeles, and Jeremy Richards, a partner at Pachulski Stang Ziehl & Jones in Los Angeles who represents the bankruptcy trustee, did not return calls for comment.

The Ninth Circuit affirmed similar decisions by a U.S. bankruptcy appellate panel of the Ninth Circuit and a U.S. bankruptcy judge in Los Angeles. It was the latest development in a financial and legal saga that began when Marciano accused his former employees of having stolen millions of dollars and other assets from him.

In 2007, Marciano sued the employees, who fired back with claims of defamation and emotional distress. In 2009, Los Angeles County Superior Court Judge Elizabeth White issued final judgments for three of the employees totaling $95.3 million. Marciano appealed the judgments.

On October 29, California’s Second District of the Court of Appeal affirmed the judgments for the three employees, as well as two others, but reduced their damages to $10 million each.

Before the Ninth Circuit, the employees argued that the judgments had been pending and not stayed at the time they filed their involuntary bankruptcy petition.

"What we said was [that] as of the date we filed the involuntary [petition], if you look at a photograph then and said, ‘Is there a dispute as to liability?’ the answer is ‘No, it’s been judicially determined. Mr. Marciano is obligated to pay it,’ " Brook said. "Is there a dispute over the amount? No, there’s a judicial determination of the amount."

The case turned on the interpretation of a "bona fide dispute" under section 303 of the Bankruptcy Code. Under that section, an involuntary bankruptcy petition may be filed by three or more entities with a claim against the person "that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount."

The majority relied on a 1986 U.S. Bankruptcy Court decision in the Southern District of New York, In re Drexler, holding that a non-default state judgment on appeal that hadn’t been stayed could never be subject to a bona fide dispute.

Ikuta, in her dissent, relied on the Fourth Circuit’s 2004 opinion in In re: Byrd, holding that state court judgments that haven’t been stayed "do not guarantee the lack of a bona fide dispute." Ikuta noted that the majority ruling conflicts with the circuit’s own 2001 decision In re: Vortex Fishing Sys. Inc., which established an objective test to determine whether a dispute is "bona fide."

"Given the circumstances of the $95 million judgments against Marciano, the bankruptcy court was at least bound to consider whether there were legitimate questions regarding Marciano’s liability and the amount of damages, as well as whether the trial court’s conclusion was contrary to the rulings of other state courts," she wrote. "As later events showed, Marciano’s contention that the employees’ claims were subject to a bona fide dispute as to amount was well justified: the state appellate court ultimately reduced the amount of each award to $10 million."

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