Many a bankruptcy attorney has been approached by an angry client who is owed a large amount from, or has obtained a judgment against another party, but has been frustrated in efforts to collect and wants to “throw them into bankruptcy.”  After trying to calm the client down, the attorney will go over the technical requirements for commencing an involuntary bankruptcy case and will undoubtedly carefully explain the financial risks that lie in wait in the event that the putative debtor opposes the bankruptcy and is successful in having it dismissed.  Specifically, section 303(j) of the Bankruptcy Code authorizes the bankruptcy court to award against petitioners and in favor of the debtor costs, or reasonable attorney’s fees, if an involuntary petition is dismissed other than on consent of all petitioners and the debtor.  Even scarier, if the court concludes that the involuntary petition was filed in “bad faith,” it may grant judgment against any petitioner for any damages proximately caused by such filing, or punitive damages.  Even if the technical standards for an involuntary filing are met, however, a creditor may find itself in serious “hot water” with the bankruptcy court if the judge determines to dismiss the case based on creditor misconduct, as the petitioning creditor in In re Matthew M. Murray, Case No. 14-10271 (Bankr. S.D.N.Y. 2016) (REG) discovered.

In Murray, recently retired Southern District of New York Bankruptcy Judge Robert E. Gerber – one of the most respected and even-tempered bankruptcy jurists in the country – issued a scathing opinion dismissing an involuntarily filed bankruptcy case for “cause,” including on the basis that the filing was likely made in “bad faith” on the part of the petitioning creditor, who the Judge concluded was improperly seeking to “misuse” the bankruptcy court as a “collection agency.”

The sole petitioning creditor in Murray, which happened to be a law firm, was the assignee of what had ballooned into a $19 million judgment against Mr. Murray arising out of a FINRA arbitration award.  It was undisputed that the law firm commenced the involuntary against Murray in order to obtain the benefit of Section 363(h) of the Bankruptcy Code, which permits, in certain instances, the forced sale of real property in which a debtor has only a joint interest with another party – in this case, an apartment that was jointly owned, as tenants by the entirety, by Mr. Murray and his wife, where they lived together with their children.  This remedy is unique to bankruptcy law and would otherwise be unavailable in a state court judgment enforcement proceeding in New York, where the judgment was entered.  Under New York law, because the judgment was entered only against Mr. Murray and not his wife, the law firm could have only executed against and forced a sale of Mr. Murray’s interest in the apartment – but not his wife’s –which would be an unattractive asset for a potential buyer.  Under Section 363(h) of the Bankruptcy Code, however, an apartment held by tenants in the entirety can be sold free and clear of both owners’ interests, with the non-debtor party (in this case the wife) only having a right of first refusal to match the purchase offer if she wished to stay in the apartment, in addition to receiving her share of the sale proceeds.

Although neither the parties nor the court disputed that the involuntary petition in Murray met the minimum filing requirements under section 303 of the Bankruptcy Code – which permits an involuntary filing by a single creditor when the debtor has fewer than 12 creditors – the fact that the petitioning creditor law firm was Mr. Murray’s only creditor presented the Court with the purest form of the archetypal “two-party dispute,” which often serves as the key factor in determining whether “cause” exists for the dismissal of a bankruptcy case, including on the basis that the case was filed in “bad faith.”  With the law firm admittedly having commenced the case in order to enhance its rights against Mr. Murray (or, as was suggested by Murray, to obtain leverage in long-stalled negotiations), the court concluded that “whether for ‘bad faith filing,’ or merely unenumerated cause, the petition must be, and is, dismissed for cause” under section 707(a) of the Bankruptcy Code, because the “bankruptcy court cannot properly be employed as a rented battlefield, to achieve ends for which it never was intended, and as a collection mechanism ….”  The court neatly summed up its analysis as follows:

Here—where the filing arises solely from a two-party dispute; the bankruptcy case was filed solely as a judgment enforcement mechanism; the filing has been made solely to achieve a result unavailable under nonbankruptcy law; where there are no other creditors’ needs and concerns to protect; and where there are no other bankruptcy goals to achieve—the Court will not countenance misuse of the bankruptcy system in this way.

Then, characterizing the actions of the law firm as “an inappropriate invocation—and exploitation—of the bankruptcy system,” the court delivered its scalding verdict:

What the Law Firm doesn’t understand, or disregards, is that just as “[t]he bankruptcy court is not a collection agency,” bankruptcy is not a judgment enforcement device. 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 the most aggressive, of them.

This bankruptcy case has no raison d’être. The sole purpose for this filing is the desire of the debtor’s only creditor to use bankruptcy as a judgment enforcement device—and to secure a debt collection remedy that is more potent in bankruptcy than the equivalent right under nonbankruptcy law. That falls far short of a reason for commencing a process intended for the benefit of many creditors, not a single one, and for achieving other goals, none of which would be accomplished here.

The Murray case serves as a stark warning that if an involuntary petition arises solely out of a two-party dispute and is used as a “judgment enforcement device,” it will likely be dismissed.  Moreover, as noted above, if the filing was determined to have been made in bad faith, the creditor may be subject to any damages proximately caused by such filing, or even punitive damages.  In Murray, the petitioner – perhaps miraculously – escaped with a mere dismissal of the case and no sanctions because the parties elected to proceed on a non-evidentiary basis and the court determined that it had an insufficient factual record before it in order to award sanctions.  Nevertheless, while involuntary bankruptcies constitute less than 1/10 of 1% of all bankruptcy cases that are filed, the Murray decision will likely cause even that small percentage to shrink.