Most bankruptcy cases are commenced by the filing of a “voluntary” bankruptcy petition by the debtor. In fact, as we have reported previously, today the bankruptcy process is dominated by prearranged restructurings involving advance planning and negotiations with potential purchasers and stakeholders that result in the business aspects of the bankruptcy process being substantially finalized at the time of the filing. That being said, the bankruptcy code provides that, under certain circumstances, a creditor can commence an involuntary bankruptcy case against a debtor, and if the debtor consents or the Bankruptcy Court determines the requirements have been satisfied, an order for relief is entered and the bankruptcy case proceeds with administration.
In a recent decision issued by the U.S. Bankruptcy Court by the District of Nevada in In re EB Holdings II, Case No. 17-12642-MKN (Bankr. D. NV., Dec. 15, 2017), the court reviewed the debtor’s request to dismiss an involuntary petition filed against it, or in the alternative, to suspend the matter until pending state court actions were adjudicated.
The State Court Litigation Between Debtor and Lenders
The opinion describes in detail two Nevada state court actions filed in 2016 (the Nevada actions) between EB Holdings II (the debtor) and certain of its lenders (the lenders) under a 2007 loan agreement. In the first Nevada action, the debtor asserted four causes of action, including that improper acceleration of the loan should result in cancellation of the indebtedness. The lender defendants filed a motion to dismiss, asserting that improper acceleration of the loan had not occurred, and even if it had, it would not result in cancellation of the debt.
In the second Nevada action, the lenders sued the debtor and certain third parties asserting, among other things, various fraudulent transfer, racketeering, and breach of contract claims. The debtor filed an answer and counterclaims, which again asserted that the loan obligations should be cancelled as a result of improper acceleration. The lenders filed a motion to dismiss the counterclaims, again asserting proper acceleration and opposing cancellation of the debt.
The Nevada state court denied both of the lender motions, and the lenders appealed those decisions to the Nevada Supreme Court. The Nevada Supreme Court had not issued a ruling at the time the Bankruptcy Court issued the opinion. Meanwhile, the two Nevada actions had been “coordinated” by the Nevada state court, with trial set to occur in April 2018.
The involuntary bankruptcy proceeding was filed in May 2017 by the administrative agent under the loan agreement and six of the holders of the outstanding debt (petitioners). The petitioners alleged claims against the debtor in the aggregate amount of approximately $1.3 billion, which they alleged was approximately 76 percent of the total $1.8 billion in aggregate claims related to the loan agreement. The debtor responded to the involuntary bankruptcy petition by filing a motion to dismiss the petition or, alternatively, for the Bankruptcy Court to suspend the bankruptcy proceeding to permit adjudication of the Nevada actions. The petitioners objected to the debtor’s motion. The Bankruptcy Court held a hearing in July 2017, and issued its opinion on Dec. 15, 2017. The parties also stipulated to modify the automatic stay to permit the Nevada actions to proceed during the “gap period” between the filing of the involuntary petition and entry of an order for relief if the involuntary petition was granted.
Suspension is Warranted
The opinion reviews in detail the requirements for granting an involuntary petition and procedural roadmap for adjudication. The Bankruptcy Court began its analysis by addressing the requirements for filing of an involuntary bankruptcy petition. First, an involuntary petition may only be commenced against an entity that can be a debtor under the Bankruptcy Code, see 11 U.S.C. Section 303(a). The involuntary bankruptcy petition may be filed by three or more entities that hold claims against the alleged debtor if each of the claims are not contingent as to liability and not subject to a bonafide dispute as to liability or amount, and the aggregate amount of such claims is at least $15,775 more than any lien on property of the debtor, see 11 U.S.C. Section 303(b)(1). Alternatively, if there are fewer than 12 holders of such claims, an involuntary petition may be filed by one or more such holders that hold aggregate debts of at least $15,775, 11 U.S.C. Section 303(b)(2). The Bankruptcy Court concluded that because neither the debtor nor the petitioners alleged that the debtor had less than 12 creditors, three qualified petitioners were required.
The Bankruptcy Court then described the separate requirement that if an alleged debtor contests the allegations of an involuntary petition, an order for relief is entered only if the debtor is “generally not paying such debtor’s debts as such debts become due unless such debts are the subject of a bonafide dispute as to liability or amount,” 11 U.S.C. Section 303(h)(1). Courts in the Ninth Circuit apply a “totality of the circumstances” test to deciding whether an alleged debtor is generally not paying its debts when due. Under that approach, courts consider a number of factors, including the number and amount of unpaid claims, the materiality of nonpayment, and the debtor’s overall conduct of its financial affairs. The Bankruptcy Court also noted, “A ‘bona fide dispute’ exists if there is an objective basis for either a factual or legal dispute as to the validity of a debt.”
With those standards in mind, the Bankruptcy Court turned to the debtor’s motion to dismiss. The debtor argued that the debt asserted by the Petitioners arising from the loan agreement were subject to a bonafide dispute as evidenced by the ongoing Nevada actions. The debtor also argued that the obligations were not currently due because the lenders wrongfully accelerated the loan. As a result, the debtor argued that the eligibility requirements for a petitioning creditor had not been met under section 303(b) and prerequisites for entry of an order for relief under Section 303(h) were not satisfied. As such, the involuntary petition failed to state a claim upon which relief could be granted. The opinion notes that the parties requested the Bankruptcy Court take judicial notice of dozens of documents from the Nevada Actions. In this context, the Bankruptcy Court concluded that the issues were “ill-suited to resolution by a pleading motion, which shall be treated in the nature of a motion for summary judgment.”
Turning to the debtor’s alternate request for suspension of the case, the Bankruptcy Court wrote, “a bankruptcy court may dismiss a case or suspend all proceedings in a case, at any time, if the interests of creditors and the debtor would be better served by such dismissal or suspension,” see 11 U.S.C. Section 305(a)(1). The Bankruptcy Court also noted that unlike the dismissal or conversion of a voluntary Chapter 11 proceeding or the appointment of a Chapter 11 trustee, the focus is not on the best interests of creditors and the estate, but the interests of both the creditors and the debtor. A bankruptcy court should again review the “totality of the circumstances” in deciding whether to abstain under Section 305 of the Bankruptcy Code, and consider such nonexclusive factors as: “economy and efficiency of case administration, the availability of another forum to protect the interests of the parties or the pendency of another proceeding in state court, the necessity for a federal proceeding to achieve a just and equitable solution, the availability of alternative means to equitably distribute assets, whether the debtor and creditors are able to achieve a less expensive arrangement out of court, whether continuation of existing nonfederal insolvency proceedings would be less costly and time-consuming, and the purpose for seeking bankruptcy jurisdiction.”
In this case, the Bankruptcy Court emphasized the importance of considering the interests of the nonpetitioning lenders and the debtor. The opinion describes how, if the Bankruptcy Court entered an order for relief against the debtor, all creditor claims, including those claims held by both the petitioners and the other nonpetitioning Lenders, would shift to the Bankruptcy Court. While that result might be desirable to the petitioners, it might be equally undesirable to the non-petitioning lenders who prefer a different forum. The Bankruptcy Court also described how an order for relief in an involuntary bankruptcy provides “obvious strategic advantages” to a creditor embroiled with a debtor in state court litigation. A bankruptcy trustee might seek to avoid transfers, settle existing litigation, and settle the debtor’s causes of action. The petitioners were litigating with the debtor in the Nevada actions, but other lenders were not.
The Bankruptcy Court concluded that suspension of the involuntary case to permit the Nevada actions to proceed was appropriate. First, the parties had already stipulated to modify the automatic stay to permit the Nevada actions to continue during the “gap period” between the filing of the involuntary petition and the entry of an order for relief. The abstention requested by the debtor would essentially mirror that stipulation. The Bankruptcy Court also reasoned that the conclusion of the Nevada actions would result in a final determination of the enforceability of the loan agreement, out of which most if not all of the claims in the bankruptcy case arise. Finally, the Bankruptcy Court also desired to avoid issuing rulings inconsistent with the Nevada courts.
This case presented a situation where the bankruptcy court decided it will be better for all stakeholders to allow the Nevada actions to be adjudicated—thereby determining if there was a bonafide dispute and whether the debtor could pay its debts generally when they come due, rather than hold further proceedings in the bankruptcy court on the petition and adjudicating the same state laws issues in the bankruptcy forum.
Andrew C. Kassner is the chairman and chief executive officer of Drinker Biddle & Reath, a national law firm with more than 635 lawyers in 12 offices. He chaired the corporate restructuring group for almost 20 years. He can be reached at email@example.com or 215-988-2554.
Joseph N. Argentina Jr. is an associate in the firm’s corporate restructuring practice group in the Philadelphia and Wilmington, Delaware, offices. He can be reached at firstname.lastname@example.org or 215-988-2541.