Categories & Search

Federal Appeals Court Rules on Requirements for Involuntary Bankruptcy

Section 303 of the Bankruptcy Code allows creditors to initiate an involuntary bankruptcy case against a debtor. The petition initiating the case must be filed by creditors holding claims aggregating to at least $10,000,[1] and those claims must not be “contingent as to liability or the subject of a bona fide dispute as to liability or amount.” 11 U.S.C. § 303(b)(1). Courts have disagreed as to how this provision applies when a portion of a claim is undisputed. Some courts have held that, when the undisputed portion of a claim is sufficient for the aggregated claims to reach $10,000, a dispute about the remainder of the claim does not disqualify the claim as a whole. Other courts have held that any bona fide dispute about the amount of a claim is a “bona fide dispute as to liability or amount” that prevents a claim from being used to support an involuntary bankruptcy petition. On November 26, inMontana Department of Revenue v. Blixseth, 942 F.3d 1179 (9th Cir. 2019), the Ninth Circuit embraced the second position, ruling against a state tax agency that had a large tax claim against the debtor, most of which was subject to bona fide dispute but $200,000 of which was not.

In April 2011, the Montana Department of Revenue (“MDOR”) and two other creditors, later joined by a fourth creditor, initiated an involuntary bankruptcy case against Timothy L. Blixseth, a co-founder of the private ski resort Yellowstone Mountain Club. MDOR’s claim was based on an audit that found a deficiency of $56.8 million. Prior to the petition, Blixseth had contested all of the audit findings except one disallowed deduction, which MDOR calculated as giving rise to $216,657 owed.

Blixseth moved to dismiss the petition on the ground that the underlying claims were ineligible under section 303 because they were subject to bona fide disputes. The bankruptcy court converted the motion to one for summary judgment and held that the claims of MDOR and two other creditors were subject to bona fide dispute, and thus granted summary judgment in favor of Blixseth. (When a debtor has twelve or more creditors, as the bankruptcy court found Blixseth did here, an involuntary bankruptcy petition can only be brought by three or more creditors.) The district court affirmed. MDOR appealed to the Ninth Circuit.

The Ninth Circuit began its analysis by discussing the history of the bona fide dispute provision in section 303(b)(1). The court explained that the requirement that the claims not be subject to a bona fide dispute was enacted in 1984 to address the risk of creditors using bankruptcy to coerce debtors to pay disputed claims. The 1984 version, however, did not define the meaning of “bona fide dispute” and courts disagreed about whether a dispute as to the amount of the claim, as opposed to one about liability, qualified as a “bona fide dispute” under the statute. The Ninth Circuit, interpreting the 1984 language, held in 2004 that only a dispute as to amount that brought the aggregate value of the claims below the statutory threshold qualified as such a dispute. Focus Media, Inc. v. Nat’l Broad. Co. (In re Focus Media, Inc.), 378 F.3d 916, 926 (9th Cir. 2004). Section 303 was then amended in 2005 to state that the claims must not be “the subject of a bona fide dispute as to liability or amount.”

The Ninth Circuit noted that courts have been evenly split on the effect of the 2005 amendment. Some courts have held, consistent with a literal reading of the text of the statute, that any dispute as to amount makes a claim ineligible under section 303(b)(1). Other courts have held that Congress was simply ratifying the approach of cases like Focus Mediadecided prior to the amendment, and a dispute about the amount of a claim that does not bring the aggregate amount below the statutory threshold of $10,000 does not affect the claim’s eligibility under section 303(b)(1).

The Ninth Circuit agreed with the first approach. The court emphasized that this reading was most consistent with the plain language of the statute. The text does not qualify “amount” and does not cabin its scope to disputes about amount that bring the claims below the statutory threshold. While the court acknowledged that prior bankruptcy practice is informative, it held that such practice did not justify departing from the plain text here. The court explained that prior to the 2005 amendment, there was no uniform approach to section 303(b)(1). While the amendment clarified that a dispute about amount qualifies as a “bona fide dispute,” it did not clearly adopt the Focus Mediaapproach.

The Ninth Circuit noted that its approach agreed with the two other circuit court decisions interpreting section 303(b)(1) from the First Circuit and the Ninth Circuit. See Fustolo v. 50 Thomas Patton Drive, LLC, 816 F.3d 1, 10 (1st Cir. 2016); Credit Union Liquidity Servs., LLC v. Green Hills Dev. Co. (In re Green Hills Dev. Co.), 741 F.3d 651, 660 (5th Cir. 2014). It rejected MDOR’s argument that its reading leads to an absurd result. Instead, the court said, the facts here actually illustrate how the plain-meaning reading better accords with the policy purpose of preventing creditors from using bankruptcy to coerce debtors into paying disputed claims. MDOR sought to leverage the undisputed $200,000 portion of its claim to collect on a disputed claim that was several times larger, which is precisely what the bona fide dispute provision is meant to prohibit.

The Ninth Circuit thus affirmed the rulings of the bankruptcy court and the district court that MDOR lacked standing as a petitioning creditor.

[1] This statutory threshold is periodically adjusted for inflation by regulation. At the time of the petition, the threshold was $14,425.