Late last month, the Third Circuit established new law that anyone considering the filing an involuntary bankruptcy petition must review. The precedential case is In re: Forever Green Athletic Fields, No. 14-3906, (3d Cir. October 16, 2015). Forever Green is a judgment debtor to Charles and Kelli Dawson on a $300,000 Louisiana consent judgment for unpaid commissions and wages. At the same time, Forever Green has sued one of its main competitors, a company owned by the Dawsons called ProGreen. Because Forever Green was refusing to pay off the judgment held by the Dawsons—ostensibly because there were other secured creditors ahead of them—the Dawsons found one other creditor and filed an involuntary bankruptcy petition against Forever Green.
It was undisputed in the case that the statutory requirements of the Bankruptcy Code were met for the filing of an involuntary bankruptcy petition and that Forever Green was not paying its debts as they became due. The question was whether, in light of these facts, the bankruptcy court had properly concluded that the involuntary petition had been filed in bad faith. Specifically, the court considered whether the true intent of the Dawsons was to frustrate the ProGreen lawsuit and to collect on a debt, and whether those intentions amounted to bad faith.
Adopting a "totality of the circumstances" test for determining bad faith, the court held that the Dawsons had acted in bad faith in filing the involuntary petition. The court seemed particularly troubled by deposition testimony from Mr. Dawson that he viewed the involuntary petition as part of a litigation strategy. The court said such conduct runs counter to the "spirit of collective creditor action that should animate an involuntary filing." In reading the decision, it appears that only very strong evidence of neutral intent, such as preferential payments to creditors, dissipation of assets or fraudulent transfers, will justify an involuntary petition.
This decision is troubling on many levels. First, the amount of evidence needed to prove the new totality of the circumstances test appears to be quite substantial. After all, you don't often have evidence of preferential payments, trucks backing up to loading docks on holiday weekends to spirit away assets or fraudulent transfers until long after the assets are gone. Second, when lawyers think of bad faith, we tend to think of outrageous conduct. Here, however, as noted in the opinion, the statutory requirements for the filing of an involuntary petition were met. Consequently, creditors now need to consider as well this new totality of the circumstances test for bad faith. Third, a finding of bad faith under the Bankruptcy Code means damages, potentially punitive damages, for the petitioner and/or its law firm. It is almost certain then that this new totality of the circumstances standard is going to make many creditors who otherwise have a strong statutory basis for filing involuntary petitions very nervous about actually filing an involuntary petition.
Bottom Line: Anyone considering the filing of an involuntary petition in the Third Circuit should carefully review the facts of their case to ensure that, considering the totality of the circumstances, there are at worst neutral reasons for the filing. Any factors that suggest the involuntary filing is motivated primarily to assist an individual creditor's litigation strategy or collection efforts should be especially scrutinized so as to ensure there are counterbalancing collective factors that benefit all creditors.
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