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The Bankruptcy StrategistFeaturesBankruptcyLitigation

Involuntary Bankruptcy: Limited Remedy and Strong Sanctions for Abuse

By Michael L. Cook
July 01, 2019

The remedy of involuntary bankruptcy "exists as an avenue of relief for the benefit of the overall creditor body …. [I]t was not intended to redress the special grievances, no matter how legitimate, of particular creditors …." In re Murray, 900 F.3d 53, 59-60 (2d Cir. 2018). The courts of appeals have been consistent. In re Edgar A. Reyes-Colon, 2019 WL 1785039, at 1 (1st Cir. Apr. 24, 2019) (affirmed dismissal of involuntary petition filed by only two creditors; at least three petitioners required; parties engaged in "twelve years of litigation concerning the number of [debtor's] creditors and whether he might … be placed in bankruptcy involuntarily for 'equitable' reasons."); In re 8 Speeds 8, Inc., 2019 WL 1891802, at 3 (9th Cir. Apr. 29, 2019) (dissent) ("Involuntary bankruptcy is a drastic course of action that carries significant consequences, and '[f]iling an involuntary petition should be a measure of last resort' …. The fee-shifting and damages provision of [Bankruptcy Code] §303(i) are intended to deter frivolous filings …. The Majority holds that … a third party who appears for a debtor and successfully defends against an involuntary petition can never request that the debtor be awarded costs, a reasonable attorney's fee, or damages.").

A bankruptcy court decision recently detailed how courts applying Bankruptcy Code (Code) §303(i) can sanction creditors who "abuse … the power given to [them] … to file an involuntary bankruptcy petition." In re Anmuth Holdings LLC, 2019 WL 1421169, at 1 (Bankr. E.D.N.Y. Mar. 27, 2019). Because the three involuntary petitions against corporate entities in Anmuth admittedly "lacked any merit," Id. at 12, the court ultimately awarded the debtors attorneys' fees, punitive damages, retroactive dismissal of the involuntary petitions to the dates on which they were filed, and an injunction against future filing by the petitioning creditors. Id. at 27. The decision shows why the filing of an involuntary bankruptcy requires careful pre-filing legal judgment.

Legal Background

A law professor stated 25 years ago that "[i]nvoluntary cases make up quite a small percentage of the bankruptcy filings each year, which shows how far the emphasis has moved from bankruptcy as a creditors' remedy." Brian A. Blum, Bankruptcy and Debtor/Creditor, §15.5.1, at 216 (Little, Brown & Co. 1993). The Second Circuit confirmed in Murray that "far fewer [cases] are initiated as involuntary petitions by creditors, much less a single creditor," citing statistics from the Administrative Office of the United States Courts and quoting the bankruptcy court: "less than 1/10 of 1% of all bankruptcy cases" are involuntary. 900 F.3d at 590.

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