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Court Dismisses Involuntary Chapter 11 Case on Findings of Bad Faith and Failure to Meet Standards under Section 303

In re Metrogate, LLC, No. 15-12593 (KJC), 2016 WL 3150177 (Bankr. D. Del. May 26, 2016), (with note regarding In re Diamondhead Casino Corp., No. 15-11647 (LSS), 2016 WL 3284674 (Bankr. D. Del. June 7, 2016))

In this Opinion, the Delaware Bankruptcy Court dismissed an involuntary chapter 11 case against Metrogate, LLC f/k/a Advance Realty Group, LLC (“Metrogate”) on findings that it failed to meet the standards under section 303 of the Bankruptcy Code and was filed in bad faith.  Judge Kevin J. Carey’s ruling clarified statutory requirements under section 303 and confirmed bad faith as an independent ground for dismissal of involuntary cases under the Third Circuit’s holding in In re Forever Green Ath. Fields, Inc., 804 F.3d 328 (3d Cir. 2015).

The involuntary case was filed against Metrogate, a Delaware LLC, by four funds (the “Funds” or the “Petitioning Creditors”, and, together with Metrogate, the “Parties”) that were owed more than $60 million on two notes.  Op. at *1-5. The Parties had an extensive history prior to the bankruptcy that included an action brought by the Funds in New York state court (the “New York Action”) alleging Metrogate had defaulted on its obligations and that its insiders had siphoned assets for their own benefit.  The New York Action was still pending at the time of the bankruptcy filing and had been litigated “energetically” by both sides, including rulings on a motion to dismiss and motion to amend – both of which were subject to pending appeals – and counterclaims by Metrogate seeking dismissal of the action and $60 million in damages.  Op at *6-9.

It was against this backdrop that the Petitioning Creditors filed the involuntary petition, bringing the issues from the New York Action into the Bankruptcy Court.  The Petitioning Creditors asserted bankruptcy was necessary to prevent further dissipation of Metrogate’s assets by insiders.  Op. at *10-11.  In response, Metrogate moved to dismiss the bankruptcy case, asserting that it was nothing more than a bad faith litigation tactic designed to, among other things, resurrect claims that had received adverse rulings in the state court litigation.  Op. at *1-2.

The dispute required Judge Carey to examine the language of section 303 of the Bankruptcy Code, which provides that an involuntary chapter 7 or 11 petition may only be filed:

“by three or more entities, each of which is either a holder of a claim against such person that is not contingent as to liability of the subject of a bona fide dispute as to liability or amount, or an indenture trustee representing such a holder, if such noncontingent, undisputed claims aggregate at least $15,325 more than the value of any lien on property of the debtor securing such claims held by the holders of such claims . . . .”

11 U.S.C. § 303(b)(1).

Though the Petitioning Creditors met the first prong of the statute, Judge Carey found their claims were in bona fide dispute.  This was evidenced by the ongoing and strongly contested litigation between the Parties in the New York Action.  Op at *16.  Nonetheless, the Petitioning Creditors’ argued that the involuntary petition was permissible under the Third Circuit’s holding in B.D.W. Assoc. Inc. v. Busy Beaver Bldg. Ctrs., Inc. that an involuntary petition may be permissible “if at least a portion of the debt is undisputed.”  865 F.2d 65, 66-67 (3d. Cir. 1989).  Judge Carey acknowledged that the 2005 BAPCPA Amendments cast uncertainty on Busy Beaver by adding language to section 303 providing that claims may not be in bona fide dispute “as to liability or amount.”  In the wake of this BAPCPA, a majority of courts have applied an “all or nothing” approach that is arguably at odds with Third Circuit precedent.  However, Judge Carey found the Petitioning Creditors’ claims were in bona fide dispute even under Busy Beaver because Metrogate disputed a “substantial” amount of the claims.  His Honor further noted that until the Third Circuit addresses the effect of the new language in section 303, “Busy Beaver is still good law.” Op. at *19-20.

As an alternative holding, Judge Carey ruled the involuntary petition should be dismissed as filed in bad faith.  In so doing, the Court confirmed the Third Circuit’s holding last year in In re Forever Green Ath. Fields, Inc., that “bad faith provides an independent basis for dismissing an involuntary petition.” Op. at *22; 804 F.3d 328, 335 (3d Cir. 2015).  Judge Carey applied a nine-part test examining whether the petition was filed for a valid purpose, such as maximizing the value of the debtor’s estate.  Op. at *27.  Judge Carey found Metrogate “demonstrated convincingly” that the Petitioning Creditors had filed the involuntary petition in an attempt to “change venues to this Court as an exercise in forum shopping” and to resurrect claims that had received unfavorable rulings in the New York Action. Op. at *31.

In an Opinion two weeks later in In re Diamondhead Casino Corporation, Judge Laurie Selber Silverstein further confirmed that in the wake of Forever Green, “a court may dismiss an involuntary petition for bad faith even when the petitioning creditors otherwise meet statutory criteria.”  Op. at *32.  Accordingly, though claims of petitioning creditors in that case met the statutory standard, Her Honor dismissed the involuntary petition as filed in bad faith because the primary purpose of the filing “was to effect a change in management.”  Op. at *1.  Though understanding and “fully appreciat[ing]” the petitioning creditors’ frustration with the debtor’s “lack of progress,” Judge Silverstein ruled that filing an involuntary petition to effect management change was not a proper purpose.  Op. at *45.