The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:
In Manolo Blahnik USA, Ltd., ___ B.R. ___, 2020 WL 4793973, 69 Bankr.Ct.Dec. 54 (Bankr. S.D.N.Y. August 18, 2020) (“MB USA”), on a motion to dismiss an involuntary petition by alleged debtor Manolo Blahnik USA, Ltd. (the “Alleged Debtor”), the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) held that an undisputed claim arising from one purchase order by the Alleged Debtor from the sole Petitioner (the “Petitioner”) qualified the latter to bring the petition even though the Alleged Debtor’s counterclaim to a second purchase order from the Petitioner created a bona fide dispute as to that claim because the counterclaim was closely “related” to it.
The MB USA opinion can be found here.
Petitioner was a subsidiary of an Italian company. There was another affiliate in the corporate family, plus the Italian parent corporation. Those companies shared some operating arrangements (for example, some common directors and advertising themselves as a package). For a while Petitioner sold upscale name brand shoes it manufactured to the Alleged Debtor under a license agreement, and the Alleged Debtor in turn sold them to retailers, including Neiman Marcus. Eventually, Petitioner terminated the agreement with the Alleged Debtor, and the parties entered into an agreement governing the termination process. The Alleged Debtor suffered financial distress, supposedly triggered by the Chapter 11 bankruptcy of Neiman Marcus. At the pertinent time, the Alleged Debtor had not paid two invoices from the Petitioner, the first (earlier one) for about $600,000 and the second for about $445,000. According to the Alleged Debtor, it was unable to pay the second invoice because someone from Petitioner’s affiliate induced Neiman Marcus to withhold payment from the Alleged Debtor pending resolution of some other issue. When Neiman Marcus filed bankruptcy without paying its debt to the Alleged Debtor, the Alleged Debtor claimed it was thereby unable to pay the second invoice to Petitioner.
Relying on the two invoices, the Petitioner filed an involuntary bankruptcy petition against the Alleged Debtor under Bankruptcy Code section 303(h)(1) (“section 303(h)(1)”), alleging that the Alleged Debtor was not generally paying its debts as they came due. The Alleged Debtor disputed part of the debt arising from the second invoice, claiming that the affiliate, parent and Petitioner were alter egos and that the affiliate’s interference with Neiman Marcus led to the Alleged Debtor’s inability to pay the second invoice. Accordingly, it contended that Petitioner did not qualify under Bankruptcy Code section 303(b) (“section 303(b)”), which requires that a petitioner hold a “claim” that is not “disputed as to liability or amount.” The Alleged Debtor did not, however, dispute the first invoice. The Alleged Debtor also argued that the petition did not meet the requirement that the Alleged Debtor was generally not paying its debts as they came due because it contained no other information about other debts or creditors. The Bankruptcy Court denied the motion and directed the Alleged Debtor to answer the petition.
The Bankruptcy Court rejected the Alleged Debtor’s contention that a dispute to any amount of a creditor’s “claim” rendered the claim “disputed” for purposes of section 303(b). In essence, the Alleged Debtor’s position was that in section 303(b) the word “claim” means “total claim” without regard to whether it is made up of a single, unified transaction or multiple discrete transactions. Hence, on the Alleged Debtor’s theory, if the debtor were to dispute any portion of a discrete transaction, a creditor “claim” arising from multiple, discrete transactions would be “disputed” and he therefore would be disqualified as a petitioning creditor. The Alleged Debtor relied in part on a textual argument. The statute uses only the singular “claim”, indicating, the Alleged Debtor reasoned, Congress’s intent to adopt a unified approach to the concept of “claim”.
After discussing the issue, the Bankruptcy Court dismissed as irrelevant the question whether a bona fide dispute as to a portion of a lone claim is sufficient to disqualify a creditor from petitioning, an issue as to which it noted there has been a split in authority since the amendment of section 303(b) to add the words “as to liability or amount” after “bona fide dispute” in 2005. After the amendment some courts since have concluded it altered the pre-amendment rule that a dispute as to a portion of a claim did not render the entire claim disputed. In the matter before it, the Bankruptcy Court explained, there were two distinct claims, the first invoice and the second invoice. To the extent it was relevant, the Alleged Debtor’s counterclaim of tortious interference related only to nonpayment of the second invoice, with the debt under the first invoice undisputed.
In dicta, the Bankruptcy Court concluded that a bona fide dispute that is in some sense integral to a claim renders that claim unusable for a petition. The most obvious example would be a recoupment defense because recoupment is really nothing more than an internal accounting of a contract to determine the net amount due one party or the other. But the relevant criterion is more expansive than recoupment, broad enough to include the Alleged Debtor’s tortious interference defense to the second invoice. The claim and tortious interference counterclaim “related to the same underlying transaction” because the Alleged Debtor claimed it could not pay the second invoice when the affiliate interfered with Neiman Marcus’s payment of the its debt to the Alleged Debtor for the shoes the latter bought from the Petitioner that generated the second invoice.
But citing Fustolo v. 50 Thomas Patton Drive, LLC, 816 F.3d 1 (1st Cir. 2016) (holding that an undisputed distinct component of a multiple-element judgment could support a petition even if the other elements were disputed), the Bankruptcy Court held that Petitioner qualified to bring the petition because the Alleged Debtor did not dispute the wholly independent first invoice. It also noted that the motion left disputed issues of material fact on the Alleged Debtor’s alter ego theory by which it purported to ascribe the affiliate’s interference with Neiman Marcus to Petitioner. It was also an open question whether the Alleged Debtor could show that there were other creditors holding sufficient qualifying debts so that Petitioner could not prove the Alleged Debtor was generally not paying its debts as they came due as required by section 303(h)(1).
MB USA reaches the right result on the question whether the Alleged Debtor’s dispute of the first invoice disqualified the Petitioner even though the Alleged Debtor did not dispute the second invoice. There is no policy reason why a completely undisputed debt should succumb to a dispute on a distinct debt so that the former does not enable a creditor to bring a petition that otherwise meets the requirements of applicable law. Each claim can be thought of as that of a separate creditor. The opinion also includes a very useful tour of applicable law on a number of points, though as noted above some of it is dicta.
But it also leaves open some interesting questions. One is what kind of relationship between a debtor’s counterclaims and a petitioner’s claims is sufficient to undermine a petitioner’s ability to use the claims to underwrite an involuntary petition. The most obvious case conceptually is recoupment (although that doctrine, too, can become cloudy given the infinite variety of transactional structures and creativity of counsel). Arguably, the standard implicit in the Bankruptcy Court’s dicta on the second invoice could be a “but for” test, which can be pretty broad and unruly.
A point worth appreciating is the implication of the Bankruptcy Court’s finding that the petition was enough get by a motion to dismiss on the question of whether the Alleged Debtor was generally not paying its debts as they came due even though it evidently did not allege other creditors and debts. In bankruptcy procedure, a motion to dismiss an involuntary petition is not like a standard motion to dismiss that challenges the pleading on its face. Rather, it is an ill-defined and varying amalgam of a motion to dismiss and something like a summary judgment motion, more like a motion to dismiss for want of personal jurisdiction. Here it appears that the Bankruptcy Court felt that Petitioner’s allegations and proof of the unpaid debts to it alone were enough to show the Alleged Debtor’s failure to pay its generally as they came due, thereby shifting the burden of going forward to create a material question of fact on the issue by, e.g., showing paid debts to other creditors, thereby invoking Petitioner’s burden of proof.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.