Involuntary Bankruptcy Petitions and Bad Faith as Grounds for Dismissal – by Scott Cohen

Scott Cohen Attorney at Engelman Berger

W2016 No. 3 Norton Bankr. L. Adviser NL 1
Norton Bankruptcy Law Adviser
Volume 2016, Issue 3
March 2016
Norton Bankruptcy Law Adviser
Involuntary Bankruptcy Petitions and Bad Faith as Grounds for Dismissal
Scott B. Cohen*

I. Introduction
I once had three clients trapped in the “gap period” for a full year.1 Others have had it worse.2 In my last involuntary bankruptcy case, the bankruptcy court bifurcated the trial. The first trial was to determine whether the technical requirements of 11 U.S.C.A. § 303 had been satisfied. After multiple trial days, the bankruptcy court found that the § 303 standards had been met. At that point, the bankruptcy court was prepared to set trial dates to consider (a) whether the involuntary petition had been filed in bad faith; and, if so (b) whether the petition should be dismissed. After receiving the ruling on March 31, 2009, for an involuntary bankruptcy commenced on February 5, 2008, the parties all agreed to a “walk away” and we never moved forward with the trial on bad faith.

Most recently, in In re Forever Green Athletic Fields, Inc.,3 the Third Circuit held that bad faith provides a basis for dismissing an involuntary bankruptcy petition regardless whether the statutory criteria for commencement of an involuntary case have been met and even when the debtor admits to not paying its debts as they come due. On the way there, the Third Circuit considered what it deemed to be an issue of first impression4 and ruled that bad faith serves as an independent basis for dismissal of an involuntary petition, even if the petitioning creditors meet the requirements of 11 U.S.C.A. § 303(b)(1).5 The Third Circuit then affirmed the bankruptcy court conclusion that the petitioners acted in bad faith.6

The reasoning of the Third Circuit’s opinion in Forever Green is explored below, including its use of statutory construction, congressional intent, and policy considerations. Forever Green is reviewed in context of Law v. Siegel,7 and Marrama v. Citizens Bank of Massachusetts.8 Lastly, some discussion is provided of how the bad faith test was applied to the facts of Forever Green—an issue that deserves more attention.

II. Forever Green
A. The Facts
Forever Green Athletic Fields sells artificial turf playing fields. Forever Green sued ProGreen, a competitor, for $5 million for diversion of corporate assets (“Suit 1”). Charles Dawson, an owner of ProGreen and a former Forever Green sales representative, would have been liable if damages were awarded in Suit 1. Mr. and Mrs. Dawson then sued Forever Green for unpaid commissions and wages (“Suit 2”). In Suit 2, the court entered a consent judgment in favor of the Dawsons. With interest and other costs, this judgment totaled more than $300,000. Forever Green did not make any payments on that judgment.

While Suit 2 was pending, the parties to Suit 1 agreed to arbitrate. However, just a few weeks after the consent judgment was entered in Suit 2, ProGreen filed a motion to terminate the arbitration. ProGreen argued that Forever Green was insolvent and that Keith Day, Forever Green’s president and an owner, did not have the ability or desire to pay the arbitrator’s fees and expenses. In addition, ProGreen said that the Dawsons had a $300,000+ judgment against Forever Green and they expected judgments in the same amount against Mr. Day very soon. As such, any monies paid as advance deposits to the arbitrator by Forever Green would be subject to execution and garnishment.

The Dawsons then domesticated their judgment in Suit 2 from Louisiana to Pennsylvania and obtained a writ of execution against the arbitrator and his law firm. The arbitrator recognized he was adverse to the Dawsons and suspended the arbitration.9 Forever Green filed a complaint in state court trying to reinstate the arbitration (“Suit 3”). Mr. Day testified that Forever Green was forced to bring Suit 3 to bar Mr. Dawson from derailing the arbitration. According to Mr. Day, if Forever Green did not terminate the arbitration, Mr. Dawson threatened to put Forever Green into bankruptcy.

After Forever Green commenced Suit 3, the Dawsons agreed to suspend the arbitration until their consent judgment was paid. The judge in Suit 3 issued a scheduling order for the parties to brief the issues identified in Forever Green’s complaint. Instead of filing a brief, the Dawsons, and a law firm which was owed $206,000 from Forever Green, filed an involuntary Chapter 7 bankruptcy petition against Forever Green.

On these facts, the Third Circuit observed that the petitioners “satisfied the statutory criteria for commencing an involuntary bankruptcy case.”10 Forever Green, however, moved to dismiss the petition as a bad-faith filing. The bankruptcy court convened an evidentiary hearing on the motion. In addition to receiving evidence of the parties’ prepetition course of conduct, the bankruptcy court heard testimony about Forever Green’s financials.

The evidence was that in 2012 Forever Green had essentially shut down its business. Its operating account had no activity and its balance never exceeded $30. Forever Green was winding down its affairs and recovering assets for its approximately 50 creditors. Forever Green had $6 million in assets, the largest by far being its claims against ProGreen for $5 million. Forever Green also had $2.3 million in debts, including a $1.3 million secured line of credit.

Although Forever Green itself had not been paying any of its debts as they came due, Mr. Day had personally paid off hundreds of thousands of dollars of Forever Green debt that he had guaranteed. That said, Mr. Day acknowledged that no monies were paid to the Dawsons. In his defense, Mr. Day said that secured creditors and certain unsecured creditors were ahead of the Dawsons in the pecking order. Mr. Day also funded the current litigation involving Forever Green and the arbitration against ProGreen.

In granting Forever Green’s motion to dismiss, the bankruptcy court explained that petitioning creditors must come to the court for a proper purpose. The bankruptcy court said that involuntary proceedings are intended to protect creditors from debtors who are making preferential payments to other creditors or from the dissipation of the debtor’s assets. In contrast, if a creditor seeks to collect on a personal debt to gain an advantage in pending litigation, or to harass the debtor, then the creditor is acting in bad faith. The bankruptcy court concluded that, even though the petitioning creditors met the statutory filing requirements, Mr. Dawson was a bad-faith creditor because he was motivated by two improper purposes: to frustrate Forever Green’s efforts to litigate its claim against ProGreen and to collect on a debt.

The district court affirmed and the Dawsons appealed.

B. Legal Analysis
The Third Circuit began its analysis by observing that it was undisputed that the petitioners satisfied the three requirements of 11 U.S.C.A. § 303(b)(1).11 The court then observed that the Bankruptcy Code also provided that the court, “shall order relief against the debtor in an involuntary case … only if … the debtor is generally not paying such debtor’s debts as such debts become due.”12 Again, the parties agreed that the debtor was not paying its debts.

Turning to the issue of bad faith, the Third Circuit noted that the one relevant reference to bad faith is found in 11 U.S.C.A. § 303(i)(2),13 which concerns post-dismissal damages. The petitioners argued that once the requirements of §§ 303(b) and 303(h) are satisfied, the subjective motives of the petitioners in filing an involuntary petition become irrelevant. Had Congress wanted to include bad faith as a separate basis for dismissal, Congress could have included it as an independent ground in §§ 303(b) or 303(h). Furthermore, unlike the bad faith dismissal of a voluntary petition, the court noted there is no for “cause” standard in § 303.

The Third Circuit launched its reasoning for imputing a good faith standard by addressing the text of § 303. The court analogizes the § 303(b)(1) criteria to “pleading a prima facie case” in that it is just the “first hurdle.” The Third Circuit could see no reason why bad faith would be relevant for determining sanctions but not available as grounds for dismissal. The court notes “[t]he better view that, by including an express reference to bad faith in § 303, Congress intended for bad faith to serve as a basis for both dismissal and damages.”14

Further analyzing the text, the Third Circuit observes that § 303(h)(1) does not contain the “shall order relief” language when referring to “not paying its debts.” From this the panel reasons that not paying its debts is a necessary but not sufficient condition for ordering relief. The Third Circuit told the petitioners that an “if” or “if and only if” clause would have been “more favorable” to their position.15

Turning from textual analysis, the Third Circuit wrote that the “bigger flaw” in the petitioners argument was that it overlooked the “equitable nature of bankruptcy.”

“As courts of equity, … bankruptcy courts are equipped with the doctrine of good faith so that they can patrol the border between good-and bad-faith filings.”16 Based upon policy considerations,17 the Third Circuit reasoned that allowing for dismissal based on bad faith “will encourage creditors to file petitions for proper reasons such as to protect against the preferential treatment of other creditors or the dissipation of the debtor’s assets.”18

After determining that dismissal for bad faith was available, the Third Circuit reviewed the dismissal for abuse of discretion based upon the totality of the circumstances test and upheld dismissal. The Third Circuit considered Dawson’s prepetition litigation strategy as indicative that Mr. Dawson would “use any means necessary to force payment of the Consent Judgment” and the abandonment of the putative debtor’s claims against ProGreen.19 The Third Circuit noted that Dawson’s actions “ran counter to the spirit of collective creditor action … . He [Dawson] put his own interest above all others.”20 The Third Circuit was also troubled by the use of the bankruptcy process to pressure the putative debtor to pay the consent judgment “without regard to Forever Green’s other creditors, many of which had priority claims.”21 The Third Circuit characterized the petitioners as trying to use the pending action as a debt-collection device. Lastly, the Third Circuit observed that the petitioners lacked any evidence that the putative debtor was engaged in preferential transfers or was depleting its assets.

C. Statutory Construction
The U.S. Supreme Court has routinely proclaimed that, “courts must presume that a legislature says in a statute what it means and means in a statute what it says there.”22 If the words of a statute are unambiguous, then “judicial inquiry is complete.”23 In the same way that courts presume that every word, phrase or clause in a statute has meaning,24 courts must presume that “every word excluded from a statute was excluded for a purpose.”25 Put another way, “when ‘Congress includes particular language in one section of a statute but omits it in another section of the same Act, it is generally presumed that Congress acts intentionally and purposefully in the disparate inclusion or exclusion.’ ”26 Courts do not typically assume that Congress has omitted a requirement from the text that it nonetheless intends to apply, “when Congress has shown elsewhere in the same statute that it knows how to make such a requirement manifest.”27 Simply put, “Under normal statutory construction, we [the Tenth Circuit] would not assume that the failure to include some item in a statute is an oversight that the court may correct.”28 In Forever Green, the Third Circuit recognized that Congress expressly included bad faith as grounds for sanctions when dismissal was warranted. Other courts, however, have made the same observation and come to the opposite conclusion.29

In Forever Green, the Third Circuit did not find any ambiguity in the statute before it implied the bad faith test into another part of § 303. Yet, from the silence regarding bad faith in §§ 303(b) & (h), the Third Circuit chose to make law out of this negative implication. This is troubling as Congress has shown the ability to explicitly include bad faith in § 303(i) and to include “for cause” dismissal in §§ 707, 1112 and 1307. In §§ 303(b) and (h), however, neither the “for cause” standard nor the bad faith language exists.

D. The Limits of Equity
In Law v. Siegel, the Supreme Court held that the bankruptcy court’s surcharge of the debtor’s exempt asset exceeded its statutory and inherent sanction powers, and federal law bars bankruptcy courts from denying an exemption on grounds not specified in the Bankruptcy Code. “[W]hatever equitable powers remain in the bankruptcy courts,” Justice Scalia wrote for a unanimous Court, “must and can only be exercised within the confines of” the Bankruptcy Code.30

In Marrama v. Citizens Bank, the Supreme Court addressed whether a debtor’s bad faith was a valid basis for a bankruptcy court to refuse to convert the debtor’s bankruptcy case from Chapter 7 to Chapter 13 under 11 U.S.C.A. § 706(a).31 As § 1307(c) contains a “for cause” dismissal or conversion provision, the Court reasoned that the debtor’s bad faith could bar him from qualifying as a debtor under Chapter 13.32 Like Siegel, however, Marrama stands for the proposition that a bankruptcy court may not exercise its authority to “carry out” the provisions of the Bankruptcy Code by taking actions prohibited elsewhere in the Code, even if it is to curb “abusive litigation practices.”33

The Third Circuit’s opinion in Forever Green omits any discussion of Siegel or Marrama. Under Siegel, the Third Circuit’s inclusion of a bad faith standard in §§ 303(b) and (h) could be seen as an exercise of equitable powers that runs contrary to the plain language of the Bankruptcy Code. Moreover, unlike Marrama, the absence of a “for cause” standard for dismissal of involuntary bankruptcy petitions leaves the Third Circuit without a safe harbor for its conclusion.34

E. Bad Faith
Generally, courts are in agreement that filing an involuntary petition to defeat state court litigation, and without a purpose consistent with the Bankruptcy Code, is in bad faith.35 Furthermore, at the appellate level, the bankruptcy court’s findings on bad faith are reviewed for an abuse of discretion. That said, some of the more far reaching pronouncements in the opinion are disconcerting.

Mr. Dawson was faulted for wanting to have his consent judgment paid and admitting to it. In so doing, he was found to have put “his own interests above all others” and violated the spirit of “collective creditor action.” In following his self-interest, Mr. Dawson tried to exert pressure on the alleged debtor and did so regardless of the priority of other claimants.

For anyone who has ever represented creditors, none of these motives should come as a surprise.36 While Mr. Dawson’s actions lack a certain purity, nobility or communal purpose, do they equate with bad faith?37 Are we so divorced from business realities that creditors who want to get paid no longer have access to involuntary bankruptcies? Ultimately, the bankruptcy court is in the best position to assess Mr. Dawson’s credibility and intentions. However, if the test for good faith is so strict that it bars self-interested creditors who merely want to get paid, then the test needs to be revisited.38

III. Conclusion
The Third Circuit’s decision in Forever Green is an excellent case study in bad faith and involuntary petitions. With the rise of textualism in the interpretation of the U.S. Constitution and federal statutes, the Third Circuit’s use of bad faith from § 303(i) to dismiss an otherwise appropriate involuntary petition under §§ 303(b) and (h) is certainly an anomaly. It is also an outlier in the trend towards a restrictive use of equity jurisprudence in bankruptcy as evidenced by Law v. Siegel, et al. While the Third Circuit’s application of bad faith to the petitioner’s conduct is not as unexpected as its legal pronouncements, in combination, the Third Circuit’s ruling in Forever Green threatens to eliminate involuntary bankruptcies as a creditor remedy, even when all of the statutory requirements have been met.


Scott B. Cohen is a shareholder of Engelman Berger, P.C., a bankruptcy boutique in Phoenix, Arizona. He can be reached at [email protected].

In re S&S Sales, Ltd., No. 2:08-bk-01095-SSC, 2009 WL 1074125 (Bankr. D. Ariz. Mar. 31, 2009).

Aron Ralston, American outdoorsman turned motivational speaker, was trapped in a canyon in Utah for five plus days and cut off his own arm to escape. But, it is too early to digress.

In re Forever Green Athletic Fields, Inc., 804 F.3d 328, 330 (3d Cir. 2015).

See Basin Elec. Power Co-op. v. Midwest Processing Co., 47 B.R. 903, 909-10 (D.N.D. 1984), aff’d, 769 F.2d 483 (8th Cir. 1985) (involuntary petition should have been dismissed by reason of creditor’s bad faith); but see Gen. Trading Inc. v. Yale Materials Handling Corp., 119 F.3d 1485, 1505 (11th Cir. 1997) (“Of course, if the petition was not dismissed, [the petitioner] could not, under the Bankruptcy Code, have been subject to the bad faith inquiry.”).

In re Forever Green Athletic Fields, Inc., 804 F.3d at 333-34.

In re Forever Green Athletic Fields, Inc., 804 F.3d at 335-37.

Law v. Siegel, _____ U.S. _____, 134 S. Ct. 1188, 188 L. Ed. 2d 146 (2014).

Marrama v. Citizens Bank of Mass., 549 U.S. 365, 127 S. Ct. 1105, 166 L. Ed. 2d 956 (2007). Special thanks to Chief Judge Randolph J. Haines (retired), whose discussion at the 2016 Norton Institute’s Bankruptcy Litigation Seminar I regarding Forever Green in the context of U.S. Supreme Court precedent sparked this article.

At his deposition, Mr. Dawson testified that he intended to “[f]ind any available asset that Forever Green may have and try to use the lien to seize it.” He also said, “I’m going to use that judgment to levy any monies I can find anywhere, whether it be the arbitrator or anyone else. So, yeah, if we can get the lien paid, that’s my number one objective. If I can get it paid, I’m very happy.”

See 11 U.S.C.A. § 303(b).

In re Forever Green Athletic Fields, Inc., 804 F.3d at 333. Section 303(b)(1) provides three requirements for filing an involuntary petition against a debtor with at least 12 creditors.

In re Forever Green Athletic Fields, Inc., 804 F.3d at 333 (citing 11 U.S.C.A. § 303(h)(1)).

Section 303(i) provides, in full:
(i) If the court dismisses a petition under this section other than on consent of all petitioners and the debtor, and if the debtor does not waive the right to judgment under this subsection, the court may grant judgment—
(1) against the petitioners and in favor of the debtor for—
(A) costs; or
(B) a reasonable attorney’s fee; or
(2) against any petitioner that filed the petition in bad faith, for—
(A) any damages proximately caused by such filing; or
(B) punitive damages.
11 U.S.C.A. § 303(i).


In re Forever Green Athletic Fields, Inc., 804 F.3d at 334.

In re Forever Green Athletic Fields, Inc., 804 F.3d at 334.

In re Forever Green Athletic Fields, Inc., 804 F.3d at 334.

For a broader discussion of the role of bad faith in dismissing involuntary bankruptcy petitions, see Lawrence Ponoroff, The Limits of Good Faith Analyses: Unraveling and Redefining Bad Faith in Involuntary Bankruptcy Proceedings, 71 Neb. L. Rev. 209, 216 (1992).

In re Forever Green Athletic Fields, Inc., 804 F.3d at 335. See also James H. Haithcock III & Robert C. Goodrich, Jr., Bad News, Will Travel Fast: Third Circuit Imposes Good Faith Condition on Involuntary Bankruptcy Petitioners, 12 Norton Bankr. L. Adviser 1 (2015) (concluding that imposing an additional, non-statutory requirement (good faith) will discourage the filing of involuntary petitions where there is no evidence that the congressionally imposed requirements are an inadequate check on alleged abuses).

In re Forever Green Athletic Fields, Inc., 804 F.3d at 336.

In re Forever Green Athletic Fields, Inc., 804 F.3d at 336.

In re Forever Green Athletic Fields, Inc., 804 F.3d at 337.

United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241-242, 109 S. Ct. 1026, 103 L. Ed. 2d 290 (1989).

Rubin v. United States, 449 U.S. 424, 430, 101 S. Ct. 698, 66 L. Ed. 2d 633 (1981); Ron Pair, 489 U.S. at 241 (“where … the statute’s language is plain, the sole function of the courts is to enforce it according to its terms.”).

See generally 2A Norman J. Singer & J.D. Shambie Singer, Statutes and Statutory Construction § 46:1, 46.6 (7th ed. 2007) (“It is an elementary rule of construction that effect must be given, if possible, to every word, clause and sentence of a statute.”); Warfield v. Salazar (In re Salazar), 465 B.R. 875, 879 (B.A.P. 9th Cir. 2012).

In re Salazar, 465 B.R. at 880 (citing 2A Statutes and Statutory Construction § 46:6).

Barnhart v. Sigmon Coal Co., 534 U.S. 438, 452, 122 S. Ct. 941, 151 L. Ed. 2d 908 (2002) (citations omitted); United States Trustee v. Hilmes (In re Hilmes), 438 B.R. 897, 904 (N.D. Tex. 2010) (applying this principle to § 707(b)). One axiom at issue is expressio unius est exclusio alterius, or the expression of one thing excludes others not expressed. Jama v. INS, 329 F.3d 630, 634 (8th Cir. 2003), aff’d sub nom., Jama v. Immigration & Customs Enforcement, 543 U.S. 335, 341, 125 S. Ct. 694, 160 L. Ed. 2d 708 (2005); Watt v. GMAC Mortg. Corp., 457 F.3d 781, 783 (8th Cir. 2006).

Jama v. Immigration & Customs Enforcement, 543 U.S. at 341.

United States v. Neal, 249 F.3d 1251, 1255 (10th Cir. 2001).

See, e.g., In re Kennedy, 504 B.R. 815, 823-24 (Bankr. S.D. Miss. 2014) (“And the plain language of § 303(i)—where bad faith is mentioned—contemplates bad faith only as a requirement for the recovery of actual or punitive damages after the involuntary petition is dismissed.”); In re Basil Street Partners, LLC, 477 B.R. 846, 849 (Bankr. M.D. Fla. 2012) (“[I]t is clear from a plain reading of the statute that § 303(i) is triggered only after the court has dismissed the petition. In other words, dismissal of the petition is a prerequisite to a bad faith inquiry and analysis.”); In re Marciano, 446 B.R. 407, 430 (Bankr. C.D. Cal. 2010), aff’d, 459 B.R. 27 (B.A.P. 9th Cir. 2011), aff’d, 708 F.3d 1123 (9th Cir. 2013) (“Section 303(b), which sets forth the requirements for filing an involuntary petition, does not contain any language regarding the good faith of petitioning creditors.”).

Law v. Siegel, 134 S. Ct. at 1194 (quoting Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 108 S. Ct. 963, 99 L. Ed. 2d 169 (1988)).

Marrama, 549 U.S. at 372.

Marrama is a 5-4 decision in which Justice Alito, joined by Chief Justice Roberts, and Justices Scalia and Thomas dissented based upon the plain meaning of the statutory language. Accordingly, the minority view opined that the debtor had an absolute and unconditional right to convert, subject to reconversion if consistent with further proceedings.

Marrama, 549 U.S. at 375-76.

It is hard to believe that Forever Green would have survived Supreme Court review given the narrowing of federal equity jurisdiction and powers in commercial disputes. See Randolph J. Haines, The Conservative Assault on Federal Equity, 88 Am. Bankr. L.J. 451, 455 (2014). For a summary of Judge Haines’ (retired) observations, see Hon. Randy Haines, The Use of Formalism to Deny Equity and Part Two: A Pragmatic Response to the Problem of Formalism, 4 Norton Bankr. L. Adviser 1 (2015).

In re Forever Green Athletic Fields, Inc., 804 F.3d at 337, n.7.

I am reminded of Captain Renault’s words in Casablanca: “I’m shocked, shocked to find that gambling is going on in here.” Is anyone really shocked that a petitioning creditor wants to get paid and does not care about the priority scheme that only becomes relevant if and only if an order for relief is entered?

If the test is too strict, we may just encourage disingenuous testimony. See In re Key Auto Liquidation Ctr., Inc., 372 B.R. 74, 78 (Bankr. N.D. Fla. 2007) (finding that petitioner, who paid the fees of all the other petitioners, had the requisite good faith when he “felt compelled by a moral obligation to the trade creditors with whom he regularly transacts business”).

In other contexts, a creditor that pursues its own self-interest is not deemed to act bad faith. See In re Monticello Realty Investments, LLC, 526 B.R. 902, 909-10 (Bankr. M.D. Fla. 2015) (refusing to designate a vote as “casting a vote does not require of the creditor a selfless disinterest” so long as the creditor “acts to preserve what he reasonably perceives as his fair share of the debtor’s estate”).