Involuntary Bankruptcy: BAPCPA Amendment to § 303(b) Needs to be Revoked

Filing an involuntary bankruptcy petition as a petitioning creditor is a precarious action. The risks involved are intense, including potential liability for the debtor’s costs, attorneys’ fees, actual damages and punitive damages.¹ To qualify as an involuntary bankruptcy petitioner, under 11 U.S.C.§ 303(b) a creditor’s claim must not be subject to a “bona fide dispute.”

Before 2005, a creditor could be disqualified under the bona fide dispute standard only if its entire
claim was disputed: “To eliminate a creditor as an eligible petitioning creditor, the bona fide dispute
must go to the entire claim. A bona fide dispute as to a portion of the petitioning creditor’s claim
does not disqualify that creditor from filing an involuntary case.”²

This “entire claim” disqualification standard was difficult and threatening enough for petitioning creditors. However, in 2005, the standard got even tougher. Since 2005, a creditor is now ineligible to be an involuntary petitioner if any portion of the creditor’s claim is disputed. A November 2023 bankruptcy opinion explained the post-2005 rule: “[A] dispute as to any portion of a claim, even if some dollar amount would be left undisputed, means there is a bona fide dispute,” and the creditor is ineligible to be a petitioning creditor under § 303(b).³ The 2005 change occurred by the addition of five words to § 303(b )(1)
(emphasis added):

b) An involuntary case against a person is commenced by the filing with the bankruptcy court of a petition under chapter 7 or 11 of this title – (1) 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 or the subject of a bona fide dispute
as to liability or amount ….

This addition occurred as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The design behind BAPCPA has been described as (1) “to deter people from pursuing bankruptcy by making filing for it more difficult and expensive, as well as less financially advantageous”;⁴ and (2) “to make filing for bankruptcy more difficult, more expensive and less financially advantageous for households.”⁵ BAPCPA’s enactment succeeded in its purpose: A million fewer consumer bankruptcy filings occurred in the two years following BAPCPA than what would have otherwise been expected.⁶ Consistent with the intention to reduce the number of bankruptcy filings, those five words were added to§ 303(b) to make petitioning-creditor eligibility more difficult to achieve.

The addition of those five words created both an irony and a tension. On the one hand, involuntary bankruptcy is an effective creditor tool for addressing a debtor’s existing and potential financial abuses (such as avoiding insider preferences and fraudulent transfers), as well as gaining bankruptcy protections (such as disclosure requirements), but on the other hand, BAPCPA views the very act of fil­ing an involuntary bankruptcy petition as a potential abuse that might need to be prevented. It is fair to suggest that Congress, in its desire to decrease the number of bankruptcy filings through BAPCPA, may have overreacted and made involuntary petitioning creditor eligibility excessively strin­gent. For example, consider this vendor hypothetical under existing§ 303(b)(l) language.

A vendor sells 100 items of its product to the debtor, and payment is now long past due. The vendor learns that the debtor is transferring assets to insiders without fair con­sideration, so the vendor accepts the invitation of two oth­er creditors to join in an involuntary bankruptcy petition against the debtor.

Once the petition has been filed, the debtor argues that one of the vendor’s 100 product items was defective – and therefore the vendor’s claim is a bona fide dispute for § 303(b)(l) purposes. In response, the vendor could pre­sumably waive its claim as to the allegedly defective item, amend the petition accordingly and still proceed.

Suppose that the debtor instead alleges that 90 of the vendor’s 100 items are defective. The vendor feels sure that the defectiveness claim is without merit and does not want to waive its claim to the 90 items, but the vendor also does not want to run the risk of a trial. In this scenar­io, the vendor may effectively be left without the ability to file an involuntary bankruptcy under § 303(b)(l) as it currently exists, which appears to portray a problem with­out a viable solution.

Purpose and History of§ 303(b)

The purpose and history of§ 303(b) shed light on this present situation.⁷ The purpose of involuntary bankrupt­cy is to provide a method for creditors to protect their rights against debtors who are not meeting their debts.⁸ Bankruptcy in general, and § 303 in particular, encourage group action by creditors and discourage a “race to the courthouse” by individual creditors for their separate ben­efit.⁹ The Bankruptcy Code’s initial version of § 303(b) did not contain a “bona fide dispute” limitation on credi­tor eligibility; the only such limitation was that the cred­itor’s claim not be “contingent as to liability.” Yet, even under that initial version, courts disagreed on whether a disputed claim would qualify as a basis for a petitioning creditor’s eligibility. ¹⁰

Congress then enacted the Bankruptcy Amendments and Federal Judgeship Act of 1984 (BAFJA) in response to the U.S. Supreme Court’s 1982 Northern Pipeline Construc­tion Co v. Marathon Pipe Line Co. decision.”¹¹ The BAFJA added the “bona fide dispute” eligibility requirement to § 303(b)(l).¹² The legislative record for the “bona fide dispute” addition includes this explanation from Sen. Max Baucus (D-Mont.) about its purpose:

Some courts have interpreted section 303 ‘s language … as allowing the filing of involuntary petitions and the granting of involuntary relief even when the debtor’s reason for not paying is a legitimate and good-faith dispute over his or her liability. This interpretation al­lows creditors to use the Bankruptcy Code as a club against debtors who have bona fide questions about their liability, but who would rather pay up than suffer the stigma of involuntary bankruptcy proceedings.
My amendment would correct this problem. Under my amendment, the original filing of an involuntary petition could not be based on debts that are the sub­ject of a good-faith dispute between the debtor and his or her creditors.¹³

Immediately following Sen. Baucus’s statement, the Senate adopted his “bona fide dispute” amendment to
§ 303(b)(l).¹⁴ President Ronald Reagan said in his statement at signing the BAFJA into law, “The bill … remedies abus­es by both debtors and creditors in consumer bankruptcy proceedings.” The BAFJA’s legislative history reflects that the primary purpose of§ 303(b)(l)’s “bona fide dispute” re­quirement for creditor eligibility is to protect debtors from coercive creditors.¹⁵

Few Involuntary Cases

The incidence of involuntary bankruptcy filings is, actually, very low.¹⁶ Bankruptcy began in 16th century England as an entirely involuntary procedure: Creditors initiated a bankruptcy proceeding by filing a complaint against their debtor. Debtors could not file for bank­ruptcy voluntarily in England or the U.S. until the mid­-1800s, and American corporations could not file volun­tarily until 1910.

Despite the late emergence of voluntary bankruptcy, it has come to utterly dominate modern American bankrupt­cy practice – at the expense of the involuntary process.¹⁷¹⁷ Today, involuntary bankruptcy plays almost no role in re­al-world practice except, perhaps, as an action available to creditors that they may threaten, but almost never exercise.¹⁸ A 2020 study of involuntary bankruptcy filings from 2007- 17 provides the following data:

Total Bankruptcy Petitions: 11,244,521
Total Involuntary Petitions: 5,512
Involuntary Petition Percentage: 0.05 percent.¹⁹

When the data focuses exclusively on bankruptcies with business debts, the numbers are dramatically less, but the percentage of involuntary cases is still less than half of 1 percent:

Bankruptcy Petitions with Business Debts: 238,906
Involuntary Petitions with Business Debts: 1,016
Involuntary Petition Percentage: 0.43 percent.²⁰

The same study also reported that many of the invol­untary bankruptcies filed from 2007-17 were filed by peti­tioners acting pro se. It is no surprise that an “overwhelm­ing majority” of pro se involuntary cases are dismissed.²¹ Thus, the study made this recommendation for improving involuntary bankruptcy law: “[A]n involuntary petition filed without an attorney’s signature should not be placed on the court’s docket or reported to credit bureaus and should not trigger the automatic stay. In short, bankrupt­cy law should ban pro se involuntary petitions.”²² Based on this evidence, it is hard to understand how Congress could conclude that involuntary bankruptcy filings are out of control and need to be limited, except for involuntary cases filed by prose petitioners.

Involuntary Bankruptcies Should Be Encouraged?

Moreover, the same study also argued that involuntary bankruptcy cases are not only a good thing … they should be encouraged! Here is the argument:

Evidence from both theory and practice suggests that the demise of involuntary bankruptcy has had signif­icant social costs …. This Article [provides] a comprehensive study of the previously vibrant practice of involuntary bankruptcy. Crucially, we find that early twentieth-century bankruptcy practice provid­ed de facto incentives for involuntary petitions by rewarding filing attorneys with lucrative post-peti­tion work. Such rewards helped overcome the col­lective-action problems that otherwise discourage creditors from filing.
The law of involuntary bankruptcy should look back to that past to find its future. We propose a number of reforms, including instituting a system of de jure “bankruptcy bounties” to encourage involuntary pe­titions that will revitalize involuntary bankruptcy and restore its rightful place in the law and theory of bankruptcy.²³

These views are at great variance with the supposed purpose of BAPCPA of tightening up eligibility for filing an involun­tary bankruptcy petition as a way to prevent abuse.

Solution

There is an important difference between being coerced by a creditor whose entire claim is in bona fide dispute vs. being placed into involuntary bankruptcy by a creditor with a completely or mostly undisputed claim (even when a portion is disputed). In managing the ten­sion between limiting the number of bankruptcy filings and providing an involuntary bankruptcy tool for credi­tors, BAPCPA’s five-word addition to§ 303(b)(l), “as to liability or amount,” should simply be removed from that Bankruptcy Code provision. abi

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1. 11 U.S.C. § 303(i). ↩︎
2. Collier on Bankruptcy, Vol. 2, 􀀥 303.03[2)[b][iii], at 303-24 & 25 (15th ed.). ↩︎
3. In re Azteca, S.A.8. de C. V., et al., Case No. 23-10385, (Bankr. S.D.N.Y. Nov. 20, 2023),2023 Bankr. LEXIS 2786. ↩︎
4. Matthew Notowidigdo, “Assessing the Bankruptcy Law of 2005,” Inst. for Policy
   Research, Northwestern Univ. (Dec. 16, 2019), available at ipr.northwestern.edu/ news/2019/assessing-the-bankruptcy-law-of-2005.html (last visited July 23, 2024). ↩︎
5. Steve Maas, “Bankruptcy Reform of 2005 Sharply Reduced Filings,” The Digest, published by Nat’I Bureau of Econ. Research (Dec. 1, 2019).­ ↩︎
6. Id. ↩︎
7. See generally Steven J. Winkelman, “A Dispute over Bona Fide Disputes in Involuntary Bankruptcy
   Proceedings,” Univ. of Chicago Law Review, Vol. 81: Issue 3, Article 10 (2014). ↩︎
8. Id. at 1344 (citing In re All Media Props. Inc., 5 Bankr. 126, 137 (Bankr. S.D. Tex. 1980); In re Apache
   Trading Grp. Inc., 229 Bankr. 891,894 (Bankr. S.D. Fla. 1999)). ↩︎
9. Id. at 1344-45 (citing Coral Petroleum Inc. v. Banque Paribas-London, 797 F.2d 1351, 1355 (5th Cir. 1986), quoting Bankruptcy Law Revision, H.R. Rep No. 95-595, 95th Cong, 1st Sess. 177 (1977), reprinted in 1978 U.S.C.CAN. 5963, 6138).­ ↩︎
10. Id. at 1345-46, see fns.21-25. ↩︎
11. 458 U.S. 50 (1982). ↩︎
12. Id. at 1347. ↩︎
13. Id. al 1347-48. ↩︎
14. Id. at 1348. ↩︎
15. Id. ↩︎
16. See Richard M. Hynes & Steven D. Walt, “Revitalizing Involuntary Bankruptcy,” 105 Iowa Law Review
    1127, at 1150-61 (2020). ↩︎
17. Id. at 1128 (citing Max Radin, “The Nature of Bankruptcy”, 89 U. Pa. L. Rev. 1, 3-4 (1940); Louis Edward Levinthal, “The Early History of English Bankruptcy,” 67 U. Pa. L. Rev. 1, 14-15 (1919); W.J. Jones, “The Foundations of English Bankruptcy: Statutes and Commissions in the Early Modern Period,” 69 Transactions Am. Phil. Soc’y, No. 3 (July 1979), at 25; John C. McCoid II, “The Origins of Voluntary Bankruptcy,” 5 Bankr. Dev. J. 361, 361 n.4-5 (1988); Garrard Glenn, “The Law Governing Liquidation: As Pertaining to Corporations, Partnerships, Individuals, Decedents, Bankruptcy, Receivership, Reorganization,” 136-40, 310 (1935)). ↩︎
18. ld.at 1132. ↩︎
19. ld. at 1152. ↩︎
20. ld. ↩︎
21. Id. at 1132. ↩︎
22. ld. ↩︎
23. Id. at 1127. ↩︎

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The American Bankruptcy Institute is a multi-disciplinary, non­partisan organization devoted to bankruptcy issues. ABI has more than 12,000 members, representing all facets of the insol­vency field. For more information, visit abi.org.

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