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In certain circumstances, creditors may file a bankruptcy petition against a debtor, essentially forcing the debtor into a repayment plan. This process, known as involuntary bankruptcy, is mostly used against businesses with substantial debts and sufficient assets to pay those debts. Involuntary bankruptcy proceedings against individuals are very rare. For most consumers, an involuntary bankruptcy would put creditors in a worse position, because they would be unable to attempt direct collection from the debtor. A recent Ninth Circuit case reviewed an involuntary bankruptcy claim brought by several individuals against another individual, addressing the question of what sort of claims meet the statutory requirements for an involuntary case. In re Marciano, No. 11-60070, slip op. (9th Cir., Feb. 27, 2013).

The case originated with a lawsuit filed by the debtor, Georges Marciano, against five employees for alleged theft. Three of those employees filed cross-complaints, which resulted in judgments in the three employees’ favor totalling $105.3 million. Marciano appealed the judgments in state court, but did not post a bond to stay enforcement. Marciano, slip op. at 4. During the pendency of the appeal, the three employees, identified in the Ninth Circuit’s opinion as the “Petitioning Creditors,” id., filed an involuntary bankruptcy petition under 11 U.S.C. § 303(b)(1) in the Central District of California.

Section 303(b)(1) allows three or more creditors to commence an involuntary bankruptcy against a debtor under Chapter 7 or Chapter 11, provided that each creditor has a claim that is not subject to “a bona fide dispute as to liability or amount.” Marciano filed a motion to dismiss, asserting several grounds, including a claim that the Petitioning Creditors’ claims are not covered by § 303(b)(1) because the judgments were on appeal at the time they filed the petition. The bankruptcy court denied the motion, and the Bankruptcy Appellate Panel affirmed. Marciano appealed to the Ninth Circuit.

A panel of the Ninth Circuit, in a 2-1 ruling, held that the Petitioning Creditors’ judgments were not subject to a “bona fide dispute” and therefore met the statutory requirements. Marciano, slip op. at 12-13. The court addressed two competing definitions of “bona fide dispute” regarding involuntary bankruptcy. Most courts follow the Drexler rule, which holds that “unstayed non-default state judgments on appeal are not subject to bona fide disputes.” Id. at 7, citing In re Drexler, 56 B.R. 960, 967 (Bankr. S.D.N.Y. 1986). The competing approach, known as the Byrd rule, gives the debtor a chance to demonstrate a bona fide dispute once the creditors have shown prima facie compliance with the statute. Marciano, slip op. at 8, citing In re Byrd, 357 F.3d 433, 438 (4th Cir. 2004). The Ninth Circuit found the Drexler rule controlling and affirmed the lower courts’ rulings. Applying the Bankruptcy Code’s definition of “claim” as a “right to payment,” the court found that an unstayed judgment on appeal gives a creditor a “right to payment,” and therefore an undisputed claim exists within the meaning of § 303(b)(1). Marciano, slip op. at 8-9.

The bankruptcy system offers relief to individuals whose income is not enough to enable them to pay their debts. It allows people, in many cases to present a plan for repaying their bills that may result in the discharge of their remaining debts. Bankruptcy attorney Devin Sawdayi has practiced in the Los Angeles area since 1997, helping countless clients through the process of personal bankruptcy. To schedule a free and confidential consultation, contact us today online or at (310) 475-9399.

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