Debtors seeking dismissal of an involuntary bankruptcy proceeding may want to consider a recent decision of the Bankruptcy Court for the District of Columbia.  In denying an individual debtor’s motion to dismiss an involuntary petition, the court in In re Barkats held that a debtor may not pay off petitioning creditors to the detriment of other creditors as a way of avoiding an involuntary petition.  

You Can’t Pay to Make It Go Away

The story began when four creditors filed an involuntary petition against Barkats, an individual debtor.  Months later, Barkats filed his list of 19 creditors, 15 of whom were not subject to a bona fide dispute and were not contingent as to liability.  Barkats moved to dismiss the case, arguing that because he already had paid off two of the four petitioning creditors’ claims, there remained an insufficient number of petitioning creditors under section 303(b)(1) of the Bankruptcy Code.

Stop Complaining and Wait and See

Among other things, section 303(b)(1) provides that when a debtor has twelve of more creditors, an involuntary chapter 11 bankruptcy case can only be commenced by three or more entities, each of which holds a noncontingent claim that is not the subject of a bona fide dispute as to liability or amount.  Barkats argued that, because he had paid off two of the four petitioning creditors, the involuntary petition did not meet the numerosity requirement of section 303(b)(1).

The bankruptcy court denied the motion to dismiss, explaining that to determine the sufficiency of an involuntary petition, bankruptcy courts look “only to the petitioners’ status as creditors on the date the original petition was filed.”  The rationale is to prevent exactly what Barkats did – avoid entry of an order for relief by paying off the petitioning creditors.  Bankruptcy courts have explained that to “deny relief simply because the debtor brings some of his debts current after the petition is filed would deprive other creditors, who remain unpaid, of the protective provisions afforded creditors under the Code.”  To allow dismissal because Barkats paid off two of the four petitioning creditors (thus arguably destroying the requisite numerosity) would disadvantage the other creditors.

Additionally, the bankruptcy court explained that Bankruptcy Rule 1003 provides a reasonable waiting period after the debtor files the requisite list of creditors to allow additional creditors the opportunity to join the involuntary case as petitioning creditors.  The court ruled that, at the time of Barkats’ motion to dismiss, the reasonable period had not yet expired and the possibility still existed that one or two of the non-petitioning creditors who Barkats listed might seek to join the petition as an additional petitioning creditor.  If that happened, Barkats would “no longer be able to forestall the entry of an order for relief by complaining that there are insufficient eligible petitioning creditors.”

Although none of the petitioning creditors in this case sought to withdraw, the bankruptcy court analogized this situation – paying off petitioning creditors to destroy numerosity – to a situation where a withdrawing creditor allegedly destroys numerosity.  Citing case law, the bankruptcy court explained that withdrawal of a petitioning creditor does not render an involuntary petition insufficient for not having the requisite number of creditors under section 303(b)(1).

Nice Try, But You’re Still in Bankruptcy Court for Now

Bankruptcy courts’ goal in disallowing a creditor’s withdrawal or debtor’s postpetition payment to destroy numerosity is to protect the interests of the unpaid or non-withdrawing creditors.  As the bankruptcy court pointed out, to rule otherwise might encourage collusion between certain creditors and the debtor to the detriment of unpaid or remaining creditors.

By denying Barkats’ motion to dismiss, the bankruptcy court dashed Barkats’ dreams of walking away from the bankruptcy court at this time.  Although the bankruptcy court did not hold that the involuntary petition met the numerosity requirement, in ruling that the reasonable period for other creditors to join as petitioning creditors had not yet expired, it left open the possibility that the involuntary case would continue.  The Barkats decision reminds us that debtors cannot evade an involuntary bankruptcy by paying off petitioning creditors to the detriment of other creditors.