Federal bankruptcy law can benefit debtors and creditors alike. Provisions such as the automatic stay and absolute priority ensure a streamlined proceeding, preserving the debtor’s scarce resources for business rehabilitation and creditor repayment.  The alternative, multiple state court debt enforcement actions, would waste the debtor’s time and money on litigation (as valuable as bankruptcy lawyers may be). 

But federal bankruptcy law also has provisions that benefit particular parties while disadvantaging others.  Section 502(b)(6), for example, caps landlords’ rejection damage claims, helping the debtor but harming landlord creditors. In In re Murray, a judgment creditor creatively sought to use section 363(h) to its advantage, and to the detriment of a third-party interest holder in the debtor’s property.  The bankruptcy court for the Southern District of New York (Judge Gerber) held that the use of an involuntary chapter 7 bankruptcy filing as an enforcement tool in a two party dispute was improper and dismissed the filing for cause under section 707(a) of the Bankruptcy Code.

This involuntary case was filed by a creditor that happened to be a law firm, Wilk Auslander LLP, against Matthew N. Murray, seeking payment on a $10.7 million judgment.  Mr. Murray was unable to pay the judgment. In fact, his sole asset was his co-op apartment, which he owned with his wife as tenants in the entirety, and where the couple lived with their two children.

Under New York state law, Wilk Auslander, as a judgment creditor of Mr. Murray, only had a claim to Mr. Murray’s interest for half the value of the apartment and could only sell that one-half interest.  In contrast, under federal law, a trustee would be able to sell the apartment jointly held by the debtor and his wife free and clear of the wife’s interest under section 363(h) of the Bankruptcy Code, thereby likely increasing the amount that could be realized upon a sale of the apartment.  The wife’s only right under bankruptcy law would be one of first refusal to match the sale offer of any potential buyer and a share of the proceeds of a forced sale, but neither Mr. Murray’s nor his wife’s consent would be required to execute the sale.

Mr. Murray had no other creditors and sought dismissal of the case for cause.  The United States Bankruptcy Court for the Southern District of New York agreed, dismissing the filing for “cause” under section 707(a) of the Bankruptcy Code, finding that the case may have been filed in bad faith and, in any case, lacked a proper bankruptcy purpose.  As Judge Gerber explained, “bankruptcy is a collective remedy, with the original purpose – which continues to this day – to address the needs and concerns of creditors with competing demands to debtors’ limited assets, and with the understandable desire that the debtor’s assets not go to the swiftest, or most aggressive, of them.”

Mr. Murray, on the other hand, had only one creditor and one asset.  Bankruptcy law would be of limited utility in protecting the condo’s value from diminution, and would be of zero utility in protecting creditors from their quicker peers. Additionally, Judge Gerber seemed to find the law firm’s sophisticated legal tactic at the advantage of the debtor’s family distasteful. “What the Law Firm [Wilk Auslander] doesn’t understand, or disregards” chided Judge Gerber, “is that just as ‘the bankruptcy court is not a collection agency,’ bankruptcy is not a judgment enforcement device.’” The court dismissed the petition, leaving Mr. Murray and Wilk Auslander to sort out their differences under state law.

This case should be a reminder that single creditors should think twice before filing involuntary bankruptcy petitions in the Southern District of New York solely to execute on judgments.