Second Circuit Affirms Slashing of Unreasonable Fees In Dismissed Involuntary Bankruptcy Case

The U.S. Court of Appeals for the Second Circuit quietly affirmed a bankruptcy court's dismissal of an involuntary petition because the petitioners' "claims were the subject of bona fide disputes within the meaning of" Bankruptcy Code (Code) §303(b)(1) (petitioner may not hold claim that is "the subject of a bona fide dispute as to liability or amount"). In re Navient Solutions, LLC, 2023 WL 3487051 (2d Cir. May 17, 2023). More important, the court affirmed "the bankruptcy court's [reduced] award of a sum of $44,000 in attorneys' fees and costs" under Code §303(i)(1)(B) to the debtor, "to be paid by [the lawyer for the petitioning creditors]." The court did not dwell on the facts of this litigation, but they have major practical significance. As shown below, an involuntary bankruptcy petition is a limited, risky remedy for both creditors' counsel and debtor's counsel. The fee problems encountered by counsel for the petitioners and the putative debtor in this case provide a cautionary tale.

Relevance

Involuntary bankruptcy exists as a remedy "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 Circuits have been consistent. In re Edgar A. Reyes-Colon, 922 F.3d 13, 15 (1st Cir. 2019) (affirmed dismissal of involuntary petition filed by only two creditors; as 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., 921 F.3d 1193, 1196 (9th Cir. 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' …. [T]he fee-shifting and damages provision of [Code] §303(i) are intended to deter frivolous filings …. The Majority [in this case] 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."); In re Anmuth Holdings LLC, 2019 WL 1421169, *1, *27 (Bankr. E.D.N.Y. Mar. 27, 2019) (petitioning creditors "abuse[d] the power given to [them] … to file an involuntary bankruptcy petition"; these petitions "lacked any merit"; court awarded debtors attorneys' fees, punitive damages, retroactive dismissal of the involuntary petitions, and an injunction against future filing by petitioning creditors).

Facts

The petitioning creditors in Navient had asserted disputed refund claims against the debtor in their involuntary petition. When the debtor moved to dismiss the petition, the petitioners never opposed the motion and their counsel never appeared at the hearing on the motion. The bankruptcy court not only abstained under Code §305(a)(i) (abstention permitted when "interests of creditors and the debtor would be better served"), but also dismissed the petition on the merits and imposed the debtor's "reasonable" legal fees on the lawyer for the petitioning creditor. The reasonableness of the debtor's legal fees were the big issue, though. The district court affirmed.