Failure to Comply with Section 303(b) requirements in Involuntary Case Not Jurisdictional. Sphere Acquisition, LLC v. Bella Hosp. Grp., LLC (In re Bella Hosp. Grp., LLC), 649 B.R. 200 (B.A.P. 9th Cir. Mar. 22, 2023)

The following is a case update written by Thomas Rupp of Keller Benvenutti Kim LLP analyzing a recent decision of interest, Sphere Acquisition, LLC v. Bella Hosp. Grp., LLC (In re Bella Hosp. Grp., LLC), 649 B.R. 200 (B.A.P. 9th Cir. Mar. 22, 2023).

To read the full published decision: click here.

SUMMARY

The Bankruptcy Appellate Panel (“BAP”) for the Ninth Circuit reversed a Nevada bankruptcy court’s decision to dismiss an involuntary chapter 7 bankruptcy case for lack of subject matter jurisdiction. The Panel held that the requirements for petitioning creditors under Section 303 and Bankruptcy Rule 1003 were not jurisdictional and therefore could be waived by the debtor’s failure to timely respond to the summons.

FACTS

In 2019, the debtor entered into an agreement with the City of Henderson, Nevada, to purchase three parcels of land for a downtown development project. In 2021, the debtor sued the city and others in Nevada state court for various contract and tort claims. One of these parties, Ed Vance & Associates Architects (“EVA”), recorded a notice of lien for $45,000 against the debtor’s parcels.

The petitioning creditor, Sphere Acquisition, LLC (“Sphere”), was formed on December 27, 2021, and was controlled by an individual who had been litigating against the debtor’s principal in California since December 2020. Sphere purchased the EVA claim through an agreement executed on January 24, 2022. Sphere then filed an involuntary chapter 7 bankruptcy case against the debtor on February 9, 2022—16 days after its purchase of the EVA claim. Sphere disclosed in the involuntary petition that it had purchased the EVA claim and attached a copy of the agreement, but it failed to attach the signed statement required under Bankruptcy Rule 1003 that the claim had not been transferred for the purpose of commencing the case.

The debtor did not answer the summons within the required 21 days. The bankruptcy court then entered the order for relief under section 303(h), and a chapter 7 trustee was appointed.

Sixty-eight days after entry of the order for relief, the debtor moved to dismiss the case for lack of subject matter jurisdiction. The debtor argued that Sphere was not a qualified petitioner because it purchased the EVA claim to commence the case and use it as a tool for the California litigation, and “intentionally” and “surreptitiously” omitted the signed statement required by Rule 1003(a).

Sphere countered that the debtor waived its objections by failing to contest the involuntary petition within the 21-day period provided by Bankruptcy Rule 1011(b). The trustee also opposed dismissal, agreeing with Sphere that the debtor’s argument was untimely, but also that it was in the best interest of creditors and the debtor for the case to continue because he had negotiated a sale of the property that would pay all secured creditors and net the estate just over $1.4 million.

The debtor replied that its jurisdictional argument was dispositive and could be raised at any time. The bankruptcy court agreed, granting the motion to dismiss after concluding that it lacked subject matter jurisdiction. The sale did not go forward, and Sphere appealed.

RULING

The BAP held that longstanding Ninth Circuit precedent expressly provided that the provisions of section 303 were not jurisdictional. See Rubin v. Belo Broad. Corp. (In re Rubin), 769 F.2d 611, 614 n.3, 615 (9th Cir. 1985); Mason v. Integrity Ins. Co. (In re Mason), 20 B.R. 650, 651 (9th Cir. BAP 1982), aff’d, 709 F.2d 1313, 1318-19 (9th Cir. 1983). The panel cited decisions from other circuits that agreed on this point.  See, e.g., Adams v. Zarnel (In re Zarnel), 619 F.3d 156, 169 (2d Cir. 2010).

Furthermore, the BAP cited the more recent Supreme Court decision of Arbaugh v. Y & H Corp., 546 U.S. 500 (2016), which articulated a “bright line” test that a statute is not jurisdictional unless such effect is clearly intended. Arbaugh, 546 U.S. at 516 (“[W]hen Congress does not rank a statutory limitation on coverage as jurisdictional, courts should treat the restriction as nonjurisdictional in character.”).

The BAP acknowledged that the facts underlying Sphere’s actions could have been the subject of an evidentiary hearing by the bankruptcy court; however, the debtor waived its rights to challenge the filing and any deficiencies when it failed to timely contest the involuntary petition.

AUTHOR’S COMMENTARY

The facts in this case seem to weigh heavily in favor of the petitioning creditor having acquired the claim for the purpose of filing the involuntary bankruptcy. However, once the debtor forfeited these arguments by failing to respond to the summons, it could not obtain a dismissal through defeating the involuntary petition under Section 303. The decision is amply supported by existing Ninth Circuit authority.

Less than one month after the BAP’s published opinion in Bella Hospitality, the Supreme Court issued its decision in MOAC Mall Holdings LLC v. Transform Holdco LLC, 143 S. Ct. 927 (2023), holding that a good-faith purchaser finding under Section 363(m) was not a jurisdictional bar to appeals of sale orders. MOAC also relied on Arbaugh, including for its reasoning that the separation of Section 363(m) from the statutes on bankruptcy jurisdiction further implied that Congress did not intend Section 363(m) to be jurisdictional. See 28 U.S.C. § 1334; MOAC, 143 S. Ct. at 937. The BAP did not offer that reasoning in Bella Hospitality—the text of the statute and binding Ninth Circuit precedent were sufficient—but it appears equally true for Section 303.

A close analogue to Section 303 would be the debtor eligibility requirements of Section 109. The majority of courts have found these requirements are not jurisdictional. See, e.g., Adams v. Zarnel (In re Zarnel), 619 F.3d 156, 169 (2d Cir. 2010); In re Ross, 338 B.R. 134, 138 (Bankr. N.D. Ga. 2006); In re Taylor, No. 05-35381, 2006 Bankr. LEXIS 689 (Bankr. N.D. Cal. Mar. 9, 2006).

One final point, though the BAP did not need to reach it, is that the requirement in dispute—that a petitioning creditor may not acquire a claim for the purposes of filing an involuntary bankruptcy and must submit a signed statement to that effect—does not appear in Section 303 but only in Rule 1003. As rules prescribed by the Supreme Court and not statutes promulgated by Congress, it is “axiomatic” that they cannot reduce a court’s subject matter jurisdiction.  See Fed. R. Bankr. P. 9030; Kontrick v. Ryan, 540 U.S. 443, 453, 124 S. Ct. 906, 914 (2004).

These materials were written by Thomas Rupp of Keller Benvenutti Kim LLP (trupp@kbkllp.com) in San Francisco, California. Editorial contributions were provided by Kathleen A. Cashman-Kramer of Sullivan Hill Rez & Engel APLC in San Diego, California (Cashman-kramer@sullivanhill.com).