Be Wary Of Using Involuntary Bankruptcy As A Collection Tool: An Update

• Published date: 18 December 2023
• Subject Matter: Finance and Banking, Insolvency/Bankruptcy/Re-structuring, Debt Capital Markets, Financial Services, Insolvency/Bankruptcy
• Law Firm: Cullen and Dykman
• Author: Kelly McNamee and Michael Traison

In our prior client alert, "Be Wary of Using Involuntary Bankruptcy as a Collection Tool," we were reminded to use the involuntary bankruptcy petition as a collection tool only after careful consideration of both the language and the spirit of the law. A recent case emphasizes that rule: In re TV Azteca, S.A.B. de C.V., 23-10385 (Bankr. S.D.N.Y. Nov. 20, 2023).

Five years ago we discussed the case State of Montana Department of Revenue v. Blixseth, 581 B.R. 882 (D. Nevada 2017), where four creditors ran afoul of this advice when trying to collect taxes owed by a debtor.¹

11 U.S.C. Section 303 lays out the basic requirements to file an involuntary petition, forcing a debtor into bankruptcy court. Among those requirements are that:

1. Three or more petitioners are needed if the debtor has 12 or more creditors (otherwise only 1 petitioner is required).
2. The debtor must generally be failing to pay its debts as they become due.
3. The debts owed to the petitioners must not be subject to a bona fide dispute.

Beyond the "letter of the law," the "spirit" underlying its presence in the Bankruptcy Code is to provide a method to bring to the bar a distressed and troubled situation for the general good, not a private right of action. This section was not provided as a substitute for litigation.

It is critical to meet the requirements of the statute. Should the debtor contest the involuntary, sanctions can be imposed. Moreover, if there is a finding of bad faith, sanctions will also include penalties which can be severe. When we consult with our Cullen and Dykman LLP clients, we remind them that filing an involuntary is akin to a lawsuit where they are plaintiffs and the debtor is a defendant.

The debtor has an opportunity to fight back and, if it wins, the results can be painful. Indeed, the two most problematic portions of the requirements are the phrases "generally failing to pay its debts as they become due" and "not subject to bona fide dispute." In this case, the issue was whether the debts were subject to dispute.

The United States District Court for the District of Nevada found that, if any portion of the debt owed to a petitioning creditor was in dispute, the creditor did not qualify to petition.

In the recent case, In re TV Azteca, S.A.B. de C.V., Bankruptcy Judge Lisa G. Beckerman granted a debtor's motion to dismiss holding that Section 303(b)(1) disqualifies an involuntary petitioner if there is a dispute as to even part of the creditor's claim. In this case...