Mylotte, David & Fitzpatrick

The involuntary petition does not seek relief under section 303(b)(3).1
UNITED STATES BANKRUPTCY COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
In re : Chapter 7
MYLOTTE, DAVID & FITZPATRICK :
Debtor : Bankruptcy No. 07-11861bif
.................................................
MEMORANDUM
.................................................
On March 23, 2007, Mr. Frederick C. Hanselmann (“Hanselmann”) filed an
involuntary chapter 7 petition against the partnership known as Mylotte, David &
Fitzpatrick (“Mylotte”). In accordance with an order dated May 23, 2007, Mylotte filed
an answer in opposition to the involuntary petition, pursuant to Fed. R. Bankr. P. 1003(b)
and 1011.
In its answer, Mylotte asserted that the petition should be dismissed because
Mylotte had more than eleven qualified creditors at the time this involuntary case
commenced, and so the involuntary petition was defective under 11 U.S.C. § 303(b)(1) in
that three petitioning creditors—rather than Mr. Hanselmann alone—were required to
initiate this action. (A list of Mylotte’s creditors was attached to the answer. See Fed. R.
Bankr. P. 1003(b)). Alternatively, Mylotte alleged that if a sole petitioning creditor could
properly file an involuntary petition under 11 U.S.C. § 303(b)(2), Mr. Hanselmann was
not so qualified. The putative debtor asserted that Mr. Hanselmann held a claim subject
to a bona fide dispute.1
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The factual findings under Fed. R. Bankr. P. 7052 will be made in narrative2
format. Moreover, it would be inappropriate to resolve the merits of the underlying claims
involving Mr. Hanselmann and Mylotte. See In re Biogenetic Technologies, Inc., 248 B.R. 852,
856 (Bankr. M.D. Fla. 1999). I shall simply determine the issues posed by section 303 of the
Bankruptcy Code. Thus, certain exhibits and testimony will not be addressed as they do not
affect the outcome of this dispute.
2
After Mr. Hanselmann filed his involuntary petition, four creditors filed
requests to join in the petition pursuant to 11 U.S.C. § 303(c): Arden Seven Penn
Partners, L.P. alleging that it holds a judgment against Mylotte in the amount of
$377,000; Graebel Companies, Inc., alleging that it holds a claim in the amount of
$13,399.63; Summit Court Reporting, Inc., asserting a claim of $7,843.35; and Sir
Lancellot Courier and Delivery Service, asserting a claim of $1,754.82. Mylotte contends
that these joinder requests cannot be allowed because Mr. Hanselmann filed the
involuntary petition in bad faith: viz., he knew or should have known that Mylotte had
more than eleven qualified creditors and so three petitioners were needed to initiate this
involuntary case.
A two day trial was held on the involuntary petition and Mylotte’s
opposition thereto. After consideration of the evidence presented, I find that the
following facts relevant to the contested involuntary petition were proven.2
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Among the documents constituting Ex. H-22 is a reference to a “letter3
agreement” between Mr. Hanselmann and Mylotte regarding terms of employment. Another
document in Ex. H-22 mentions that Mylotte had not been able to find it. At the trial on the
involuntary petition, the witnesses seem to agree that no written employment agreement exists.
3
I.
A.
Mylotte was a partnership that operated as a law firm since 1979. At all
relevant times, the firm had three “equity partners,” plus various non-equity partners and
associate attorneys. Mr. Hanselmann was hired as an associate attorney in the early
1990's and soon became a non-equity partner. An unwritten compensation agreement
between Mr. Hanselmann and Mylotte was entered into, involving the payment to Mr.3
Hanselmann of weekly or bi-weekly draws. Mr. Hanselmann avers that he holds a claim
against the law firm for missed draw payments. Mr. Hanselmann also asserts that he
holds a claim for unpaid monthly car allowance. Mylotte denies that it ever agreed to pay
such an allowance to Mr. Hanselmann.
There appears to be no dispute that Mylotte suffered cash flow problems for
a number of years. As a result, it is admitted that there would be weeks in which it had
insufficient funds to pay partner draws. When sufficient cash was later available, Mylotte
would retroactively pay those missed draw payments; however, Mylotte concedes that not
all missed draw payments were cured. Mr. Hanselmann in turn admits that Mylotte never
tendered any car allowance payments to him at any time during his years of employment.
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By July 1998, Mylotte was concerned that Mr. Hanselmann was not
generating sufficient business for the law firm. Ex. H-22. Indeed, his weekly draw
amount had been reduced as of October 1997. Mr. Hanselmann engaged counsel, who
proposed in August 1998 that Mr. Hanselmann’s compensation be unchanged for nine
months while he sought other employment. Id. Mylotte replied that it would continue
Mr. Hanselmann’s employment until the end of the year at his current level of
compensation while the parties attempted to work out some agreement that would permit
Mr. Hanselmann to remain with Mylotte. Id.
Apparently, no alternative agreement was reached and Mylotte terminated
Mr. Hanselmann’s employment effective July 9, 1999. Ex. H-2. Just prior to his
termination, Mr. Hanselmann’s lawyer wrote to Mylotte asserting that there existed
“compensation arrearages” owed to him, and seeking firm financial records from 1991 to
1999. Ex. H-1. Mylotte, through equity partner Edward J. David, Esquire, replied, in
part, by letter dated July 7, 1999:
As your letter correctly states, during the period of time that
Mr. Hanselmann has been with the firm he was not paid draw
which was due him at the time. The exact amount of unpaid
draw is presently being calculated. . . .
As to the payment of any sums which are determined to be
due Mr. Hanselmann we are not in a position to make a lump
sum payment. However, the firm is amenable to a mutually
agreed upon payment plan which reasonably protects Mr.
Hanselmann.
Ex. H-2.
These compensation issues were never resolved and Mr. Hanselmann
commenced suit in state court against Mylotte and its three equity partners via writ of
summons on September 2, 1999, docketed at C.P. Montg. Co. No. 99-15907. Ex. H-11.
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As part of litigation discovery, Mr. Hanselmann requested admissions of the defendants.
Ex. H-5. Among the admissions made by Mylotte was that Mylotte
5. failed and/or refused to pay Plaintiff twelve weeks of
compensation at the rate of $1,884.62 per week as of
September 30, 1997.
6. failed and/or refused to pay Plaintiff four and one-half
weeks of compensation at the rate of $1,653.85 per week
from October 1, 1997 until the date of his termination, July 9,
1999.
Exs. H-5, H-6, ¶¶ 5, 6. Later, in supplemental answers to interrogatories, Mylotte
acknowledged that Mr. Hanselmann had not received $31,250.07 in missed draw
payments. Ex. H-9, ¶¶ 17, 19.
After various discovery and venue disputes were resolved, in August 2003
Mr. Hanselmann filed a pro se a complaint against Mylotte and its three equity partners.
That complaint was later amended. Ex. A-1. In his amended complaint, Mr. Hanselmann
asserted that the defendants failed to pay him $30,057.77 in unpaid draw compensation,
and also failed to pay him for 93 months of car allowance at $400 per month (beginning
in October 1991) totaling $37,200; he also demanded unreimbursed expenses totaling
$54.35. Id. His amended complaint raised seven causes of action seeking an excess of
$50,000, plus punitive damages, attorneys fees and costs.
Mylotte and its partners defended this lawsuit by denying all liability and
asserting a counterclaim that Mr. Hanselmann wrongfully retained more than $50,000 in
compensation paid to him as an executor of an estate, which compensation rightfully
belonged to the law firm.
After these pleadings were filed, a discovery dispute ensued in this state
court lawsuit and Mylotte was ultimately sanctioned $27,000 by the court. Mr.
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Hanselmann then moved for additional sanctions against Mylotte, which the law firm
opposed partially on the basis that the firm had insufficient funds. A hearing was held in
state court on January 3, 2006, during which Mr. David testified in response to a question
from Mr. Hanselmann: “Well, we have admitted we owe you money”; and “We
acknowledge we owe you money.” Ex. A-2 (N.T. at 39, 42).
In 2005, Mylotte moved from Philadelphia to Broomall, Pennsylvania in
order to save rent expenses and because it was a smaller law firm and needed less space.
Ex. A-2 (N.T., at 13-15). By January 2006, it had reduced its attorney staff to eight, from
a previous high of forty.
On February 5, 2007, Mr. David notified Mr. Hanselmann on behalf of
Mylotte that the law firm “will cease doing business at the end of the day on February 9,
2007” and would seek a stay of the state court litigation “in the immediate future.” Ex.
H-14. As a postscript, Mr. David suggested that Mr. Hanselmann drop his lawsuit
because “[t]he bank and the City are ahead of you . . . and there isn’t enough to pay the
bank, much less the City.” Id.
Mylotte indeed did cease all business operations on February 9, 2007. Two
news articles appeared to that effect, both of which were read by Mr. Hanselmann. Exs.
H-15, H-16. One article referred to the firm’s litigation with the City of Philadelphia and
with its former landlord, Arden Seven Penn Partners, L.P. The other article referred to
Mylotte’s debts to the City of Philadelphia dating back to 1994, plus obligations owed to
Arden and to Wilmington Trust Bank.
On March 5, 2007, Mr. Hanselmann moved for the appointment of a
temporary receiver in his state court litigation. Ex. A-3. Mylotte responded by asserting
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that, in another action pending against it in the Philadelphia Court of Common Pleas
brought by Arden Seven Penn Partnership, judgment had been entered against it and the
state court judge had undertaken to “oversee the marshalling [sic] of assets and payment
of assets to the appropriate parties and to act as the receiver.” Ex. A-4, ¶ 11.
On March 15, 2007, the City of Philadelphia moved in its own litigation
against Mylotte and its “general partners,” C.P. Phila. Co. Feb. Term 2005, No. 001479,
for the appointment of a receiver for Mylotte. Ex. H-21. This motion, a copy of which
was sent to Mr. Hanselmann among others, alleged in part that the City held a stipulated
judgment against the law firm for unpaid taxes in the amount of $1.7 million, that
Wilmington Trust of Pennsylvania held a claim of $650,000, that Mylotte owed Arden
Seven Penn Partners, L.P. a judgment in the amount of $377,000, and that B&R Services
also held a judgment against Mylotte. Ex. H-21, at ¶¶ 4, 11-13.
As noted earlier, Mr. Hanselmann filed this involuntary petition on March
23, 2007. He testified that he did so because he was concerned that Mylotte had made
preferential payments to other creditors—but could not identify any such payments—and
because no hearing had been scheduled on his state court motion for a receiver.
As articulated at the trial on the contested involuntary petition, Mylotte now
maintains that all its non-equity partners agreed at the time of their employment that all
draw payments made by the firm were discretionary and made only if funds were
available. Thus, the law firm presently contends that it has no legal liability for missed
draw payments to Mr. Hanselmann. No written document to corroborate this purported
agreement with its non-equity partners exists.
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B.
Before he filed the involuntary bankruptcy petition, Mr. Hanselmann
performed legal research at a county law library. He therefore knew of the three
petitioner requirement found in section 303(b)(1). Mr. Hanselmann acknowledged that
he made only one attempt to communicate with any Mylotte creditor before filing his
petition: he telephoned MBNA about its claim against Mylotte, without receiving any
information from that entity.
Mr. Hanselmann also admitted that he studied court dockets of all lawsuits
involving Mylotte, and so he knew of judgments entered in favor of the City of
Philadephia, Arden and B&R Services prior to filing his involuntary petition. He was
familiar with a lawsuit brought against Mylotte by Esquire Reporting Services. He had
also obtained a commercial credit report on Mylotte from Equifax, which report listed the
City’s judgment, and which noted that Mylotte was current on its payments to four
unidentified creditors.
As mentioned earlier, Mr. Hanselmann also attended a January 6, 2006
hearing in state court, which hearing involved his request for the imposition of additional
sanctions against Mylotte, and Mylotte’s assertion that the law firm was in too dire a
financial condition to pay any additional sanctions. Ex. A-2. During the course of that
hearing, Mylotte produced a document reflecting outstanding payables to vendors. Mr.
David, on behalf of Mylotte, testified in state court that the law firm did not intend to pay
some of those vendors. Id., N.T. at 39-40. Mr. David’s testimony also revealed the
numerous creditor obligations of Mylotte at that time.
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Specifically, Mr. David disclosed the following: Mylotte owed its
accountant about $50,000. Id., N.T. at 16. It was habitually ten weeks delinquent in
paying federal payroll taxes. Id., N.T. at 16, 27. The law firm had been sued by the City
of Philadelphia, by Arden Seven Penn Partners, and by a court reporting service known as
B&R, as well as a copying service company known as Document Technologies. Id., N.T.
at 18, 35. Mylotte had agreed to pay AIG $50,000 in monthly payments of about $1,600
to settle a malpractice claim. Id., N.T. at 18. The law firm had a large outstanding
obligation to Wilmington Trust, and also owed money to its insurance premium finance
company. Id., N.T. at 21. At the time of this January 2006 hearing, Mylotte was in debt
to three law firms—Kolsby Gordon; Masterson Braunfeld; and DiDonato &
Winterhalter—who had represented Mylotte in different legal matters. Id., N.T. at 20-21.
And, Mylotte had unpaid credit card obligations to MBNA. Id., N.T. at 20. The hearing
also revealed that Mylotte’s records showed a payable owed to Christine McCafferty, id.,
N.T. at 42, who was identified in this involuntary dispute as being a former non-equity
partner.
As required by Fed. R. Bankr. P. 1003(b), Mylotte’s answer in opposition to
the involuntary petition included a list of current creditors of the law firm. Ex. H-17.
This list of thirty-one creditors, although not complete, see H-18, included Graebel,
MBNA, Sir Lancellot Courier, Paul J. Winterhalter, P.C., B&R Services, Masterson
Braunfeld, P.C., City of Philadelphia, Esquire Reporting Services and Arden Seven Penn
Partners.
Finally, Mylotte conceded at the trial that all four joining creditors held
unsecured claims not subject to bona fide dispute and in excess of $12,300. Mr.
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Hanselmann conceded at trial that Mylotte had twelve or more qualified creditors at the
time of his filing the involuntary petition in March 2007.
II.
Section 303 establishes various requirements before an order for relief can
be entered in an involuntary bankruptcy filing. Section 303(h) provides that if an
involuntary petition is contested:
[T]he court shall order relief against the debtor in an
involuntary case under the chapter under which the petition
was filed, only if--
(1) the debtor is generally not paying such
debtor's debts as such debts become due unless
such debts are the subject of a bona fide dispute
as to liability or amount; or
(2) within 120 days before the date of the filing
of the petition, a custodian, other than a trustee,
receiver, or agent appointed or authorized to
take charge of less than substantially all of the
property of the debtor for the purpose of
enforcing a lien against such property, was
appointed or took possession.
The petitioning creditor has the burden to establish this element, which is measured as of
the date the involuntary petition commenced. See, e.g., Bartmann v. Maverick Tube
Corp., 853 F.2d 1540, 1546 (10th Cir. 1988).
“A finding that a debtor is generally not paying its debts ‘requires a more
general showing of the debtor’s financial condition and debt structure than merely
establishing the existence of a few unpaid debts.’” In re Vortex Fishing Systems, Inc.,
277 F.3d 1057, 1072 (9th Cir. 2002) (quoting In re Dill, 731 F.2d 629, 632 (9th
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Cir.1984)). “In determining whether a debtor is generally paying its debts as they become
due, courts ‘compare the number of debts unpaid each month to those paid, the amount of
the delinquency, the materiality of the non-payment, and the nature of the [d]ebtor's
conduct of its financial affairs.’” General Trading Inc. v. Yale Materials Handling Corp.,
119 F.3d 1485, 1504 n.41 (11th Cir. 1997) (quoting In re Leek Corp., 52 B.R. 311, 314
(Bankr. M.D. Fla. 1985)); see 1 Norton Bankr. L. & Prac. 2d § 21:11 (2007).
Here, the evidence reflects that Mylotte was not operating at the time of the
involuntary petition. The firm was unable to pay its bank lender, was routinely delinquent
in federal wage tax withholdings when it was operating, was significantly delinquent in
city taxes, owed its former landlord more than $300,000, had not paid its moving
company when it moved to Broomall in 2005, was unable to pay three law firms
representing it in various litigation, and owed numerous court reporter charges. These
unpaid debts were substantial, of long standing, and habitual. Thus, if the only issue were
that posed by section 303(h), Mr. Hanselmann would have met his burden, as Mylotte
was not paying its undisputed debts as they became due. See generally In re Norris, 183
B.R. 437, 458-59 (Bankr. W.D. La. 1995).
However, section 303(b) establishes a threshold requirement for
commencing an involuntary petition. It presently states:
(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, or an indenture trustee representing such a holder, if
such noncontingent, undisputed claims aggregate at least
$12,300 more than the value of any lien on property of the
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debtor securing such claims held by the holders of such
claims;
(2) if there are fewer than 12 such holders, excluding any
employee or insider of such person and any transferee of a
transfer that is voidable under section 544, 545, 547, 548,
549, or 724(a) of this title, by one or more of such holders that
hold in the aggregate at least $12,300 of such claims[.]
Therefore, if Mylotte had twelve or more qualified creditors at the time Mr.
Hanselmann filed its involuntary petition, three qualified petitioning creditors were
statutorily required to commence an involuntary case. See, e.g., Atlas Machine & Iron
Works, Inc. v. Bethlehem Steel Corp., 986 F.2d 709, 714 (4th Cir. 1993). Conversely, if
Mylotte had eleven creditors or less, excluding “(a) claims contingent as to liability, (b)
claims subject to a bona fide dispute, (c) claims of employees of the debtor, (d) claims of
insiders of the debtor, (e) claims of recipients of transfers voidable under 11 U.S.C. §§
544, 545 (statutory liens), 547 (preferences), 548 (fraudulent transfers), 549
(post-petition transfers), or 724(a) (penalty claims),” id., at 715, then a valid involuntary
case could be commenced by only one petitioner. See, e.g., id., at 714.
Although Mylotte asserts that Mr. Hanselmann claim was the subject of a
bona fide dispute, I can only agree in part. A bona fide dispute arises only when there is
substantial factual or legal contention as to the claim. See B.D.W. Associates, Inc. v.
Busy Beaver Building Centers, Inc., 865 F2d 65, 66-67 (3d Cir. 1989); see also In re
Utilimax.com, Inc., 265 B.R. 63, 66 (Bankr. E.D. Pa. 2001) “In applying this standard,
the petitioning creditor must establish a prima facie case that no bona fide dispute exists.”
In re Rimell, 946 F.2d 1363, 1365 (8th Cir. 1991), cert. denied, 504 U.S. 941 (1992); see
also In re Elsa Designs, Ltd., 155 B.R. 859, 863 (Bankr. S.D.N.Y. 1993). Once a
petitioning creditor has done so, however, the evidentiary burden shifts to the objecting
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party to demonstrate that a bona fide dispute does exist. In re Rimell, 946 F.2d at 1365;
In re Elsa, 155 B.R. at 863. This burden must be met by some objective evidence of a
bona fide dispute because the statutory standard is not subjective. In re Rimell, 946 F.2d
at 1365. Thus, “neither the [objector’s] subjective intent nor his subjective belief is
sufficient to meet this burden.” Id.
As to a portion of Mr. Hanselmann’s claim—arising from missed draw
payments—the evidentiary record reflects that the petitioner has met his burden but
Mylotte did not meet its burden. See In re Focus Media, Inc., 378 F.3d 916, 926 (9th Cir.
2004) (“‘[I]f at least a portion of the debt that is the subject of the petition is undisputed,
the undisputed portion is sufficient to create a debt under Section 303(b)(1) not subject to
a bona fide dispute.’” (quoting IBM Credit Corp. v. Compuhouse Sys., Inc., 179 B.R.
474, 479 (W.D. Pa. 1995) (and cases cited). Conversely, as Mr. Hanselmann conceded at
closing argument, his monthly auto allowance claim arising from 1991 is in bona fide
dispute.
At a number of points in the state court litigation, Mylotte has admitted that
it owes Mr. Hanselmann for unpaid draw payments. It did so in discovery; and it did so
during the sanctions hearing in January 2006. Even prior to the lawsuit, Mylotte also
acknowledged the existence of a valid debt to Mr. Hanselmann.
Furthermore, its contention at trial in this court—that all partners
understood at the time of their hire that the firm had no legal liability to tender missed
draw payments—is uncorroborated, as well as undermined by correspondence in 1999
promising repayment, albeit over time and after the precise amount had been determined.
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Thus, the portion of Mr. Hanselmann’s claim involving missed draw payments is not
subject to a bona fide dispute.
The existence of a pending counterclaim raised by Mylotte against Mr.
Hanselmann in the state court litigation does not alter this conclusion. This counterclaim
is based upon Mr. Hanselmann’s representation of a client in 1998 and 1999, and involves
a transaction unrelated to unpaid compensation due from Mylotte, some of which
apparently predates Mr. Hanselmann’s representation of that client. As the counterclaim
is in the nature of setoff, rather than recoupment, it does not render Mr. Hanselmann’s
compensation claim in bona fide dispute. See In re Focus Media, Inc., 378 F.3d at 926; In
re BDC 56 LLC, 330 F.3d 111, 120 (2d Cir. 2003); In re Seko Inv., Inc., 156 F.3d 1005,
1008-09 (9th Cir. 1998); IBM Credit Corp. v. Compuhouse Systems, Inc., 179 B.R. at
479.
Although Mr. Hanselmann’s compensation claim qualifies under section
303(b), I need not quantify that claim for purposes of the instant challenge to the
involuntary petition, since the evidence presented at the trial also demonstrates that
Mylotte had at least twelve qualified creditors. See generally In re Eastown Auto Co.,
215 B.R. 960, 965 (B.A.P. 6th Cir. 1998) (in determining the total number of creditors for
purposes of section 303(b), only creditors holding claims not subject to a bona fide
dispute are considered); In re Atwood, 124 B.R. 402, 405-06 (S.D. Ga. 1991). Indeed,
Mr. Hanselmann conceded in closing argument that Mylotte proved it had at least twelve
qualified creditors on March 23, 2007. Thus, Mr. Hanselmann’s claim, by itself, is
insufficient to support an involuntary petition. As a result, Mylotte demands dismissal of
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this involuntary petition on the basis that this case violates section 303(b)(1). See, e.g.,
Atlas Machine & Iron Works, Inc. v. Bethlehem Steel Corp., 986 F.2d at 714.
Mr. Hanselmann responds, however, by relying upon 11 U.S.C. § 303(c),
which states:
(c) After the filing of a petition under this section but before
the case is dismissed or relief is ordered, a creditor holding an
unsecured claim that is not contingent, other than a creditor
filing under subsection (b) of this section, may join in the
petition with the same effect as if such joining creditor were a
petitioning creditor under subsection (b) of this section.
No order for relief or dismissal has been entered in this case, so any joinder requests
would be timely. Furthermore, at trial, there was evidence that four creditors sought to
join this petition under section 303(c). In order to properly join an involuntary petition,
the would-be joining creditor must itself hold a claim not subject to bona fide dispute.
Mylotte does not contest that were these four creditors permitted to join in
the involuntary petition, their claims are not subject to any bona fide dispute. Therefore,
their joinder, if allowed, would meet the three creditor requirement of section 303(b)(1).
See, e.g., In re LaRoche, 131 B.R. 253, 256 (D.R.I. 1991); see generally In re
Utilimax.com, Inc., 265 B.R. at 68.
It is clear from section 303(c) and Fed. R. Bankr. P. 1003(b) that Congress
anticipated that defective involuntary petitions would be filed and section 303(c) was
intended to permit these defects to be corrected with retroactive effect. See, e.g., In re
Crown Sportswear, Inc, 575 F.2d 991, 993 (1st Cir. 1978); In re Dino’s, Inc., 183 B.R.
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Rule 1003 provides:4
(b) Joinder of petitioners after filing
If the answer to an involuntary petition filed by fewer than three
creditors avers the existence of 12 or more creditors, the debtor
shall file with the answer a list of all creditors with their addresses,
a brief statement of the nature of their claims, and the amounts
thereof. If it appears that there are 12 or more creditors as
provided in § 303(b) of the Code, the court shall afford a
reasonable opportunity for other creditors to join in the petition
before a hearing is held thereon.
16
779, 782 (S.D. Ohio 1995); In re Fox, 1994 WL 484596, at *6 (N.D. Ill. 1994).4
Nonetheless, the vast majority of courts, along with various bankruptcy commentators,
have concluded that a bankruptcy court may dismiss a defective involuntary petition filed
by a single creditor in bad faith, even if additional creditors seek to join in the petition,
and even if their joinder would meet the three petitioning creditor requirement. See, e.g.,
In re Atlas Machine & Iron Works, Inc. v. Bethlehem Steel Corp., 986 F.2d at 716; Basin
Electric Power Cooperative v. Midwest Processing Co., 769 F.2d 483 (8th Cir. 1985); In
re Crown Sportswear, Inc., 575 F.2d at 993; Matter of Crofoot, Nielsen & Co., 313 F.2d
170 (7th Cir. 1963); In re R&A Business Associates, Inc., 1999 WL 820859, at *2 (E.D.
Pa. 1999); In re Dino’s, Inc., 183 B.R. at 782; In re Fox, 1994 WL 484596, at *6; In re
LaRoche, 131 B.R. at 256; 2 Collier on Bankruptcy, ¶ 303.09[1] (15th ed. rev. 2007). As
summarized by one bankruptcy treatise:
The overwhelming majority of courts, however apply a
judicially created bad-faith exception to § 303(c). If a
creditor files an involuntary petition with knowledge or
reason to know that more petitioners are needed, subsequent
cure under § 303(c) is not allowed. The rationale is that
public policy prohibits entertaining any case commenced
upon a petitioner’s conduct which amounts to fraud upon the
court. This policy is an extension of one formulated by courts
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under the Bankruptcy Act. While generally permitting
additional creditors “embodies the . . . charitable attitude
toward petitions mistakenly asserting that there are less than
twelve creditors,” courts do not permit a fraudulent allegation
to be cured by intervention.
1 Norton Bankruptcy Law and Practice 2d, § 21:8 (2007) (footnotes omitted) (quoting In
re Crown Sportswear Inc., 575 F.2d at 993).
The notion that an involuntary bankruptcy petition can be filed in bad faith
is consistent with Third Circuit Court of Appeals’ holdings concerning voluntary
bankruptcy petitions. See In re Tamecki, 229 F.3d 205 (3d Cir. 2000) (dismissing chapter
7 filed in bad faith); In re SGL Carbon Corp., 200 F.3d 154 (3d Cir. 1999) (dismissing
chapter 11 filed in bad faith); In re Lilley, 91 F.3d 491, 496 (3d Cir. 1996) (chapter 13
filed in bad faith warrants dismissal). There is no principled basis to permit a bad faith
involuntary bankruptcy filing. See Shinko v. Miele, 29 Fed. Appx. 890 (3d Cir. 2002)
(non-precedential).
Accordingly, if a sole creditor files an involuntary petition in clear violation
of section 303(b), knowing that three creditors are needed but hoping that two more will
join at a later date, virtually all courts properly dismiss the petition as not being filed in
good faith. See, e.g., Basin Electric Power Coop. v. Midwest Processing Co., 769 F.2d
at 486-87; see also Matter of Crofoot, Nielsen & Co., 313 F.2d 170 (7th Cir. 1963). As
expressed by one court:
Despite the liberal joinder envisioned under § 303(c), the
three creditor requirement of § 303(b) would be rendered
meaningless if subsequent joinder of additional parties were
sufficient in all cases where fewer than three creditors
originally commenced an involuntary case against a debtor
who has twelve or more creditors. Section 303(c) may
properly be invoked where a single petitioning creditor is
unaware that a debtor has twelve or more creditors. But
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The reference in the quotation to a “delay” in the entry of the order for relief5
addresses a practical effect of dismissal that in a given instance may be important.
If, as in this case, four creditors seek to join in this involuntary petition, dismissal
of this petition would not prevent those four creditors from filing their own petition. Therefore,
if they chose to act, an order for relief against Mylotte would likely be entered. The difference
concerns the reachback period for preferences under section 547 of the Code. This provision
avoids certain transfers made“on or within 90 days before the date of the filing of the petition . . .
.” 11 U.S.C. § 547(b)(4)(A). If this involuntary petition is not dismissed, the reachback period
will be measured from March 23, 2007, the date Mr. Hanselmann filed the instant petition. If
this petition is dismissed then the reachback period will be measured from the date a new petition
is filed.
Although Mr. Hanselmann stated that he filed this involuntary petition due to
concerns about preferential transfers, he was unable to specify any particular transfer. Therefore,
the practical import of the current dispute may not be present.
18
where, as in this case, a single creditor commences an
involuntary case despite knowledge that the debtor has twelve
or more creditors, the petition is deficient and should be
dismissed absent special circumstances.
Basin Electric Power Coop. v. Midwest Processing Co., 47 B.R. 903, 908 (D.N.D. 1984),
aff’d, 769 F.2d 483 (8th Cir. 1985); see also 2 Collier on Bankruptcy, ¶ 303.09[1] at 303-
72:
Although barring joinder in bad faith involuntary cases delays
the entry of the order for relief, there remain some good
reasons for retaining the judicially created bad faith exception
to section 303(c). Good faith has been read into a variety of
Bankruptcy Code provisions over the years, and as courts of
equity, bankruptcy courts have been rightly concerned about
those who subvert the bankruptcy process. . . . Unlike the
situation involving improper joint filings, where dismissal and
refiling are unnecessary, simply substituting a bad faith
creditor with a good faith creditor may not provide a suitable
solution; dismissal rather than substitution is the proper
remedy in that situation. This encourages good faith filing.
(footnotes omitted); see also 1 Norton Bankruptcy Law and Practice 2d, § 21:8 (2007).5
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19
Indeed, the dismissal of an involuntary petition brought improperly by a
single petitioning creditor occurred under the former Bankruptcy Act, even though
joinder by other creditors was generally permissible:
There is, however, a further ground upon which we think the
creditor's petition should be dismissed, and that is, that the
conclusion to be drawn from the primary facts found by the
master is clear-- that the Lane Shoe Company, on November
10, 1928, when it filed the petition, in which it alleged that the
creditors of the Navison Shoe Company, Inc., were less than
twelve, did so knowing that the allegation was false; or did so
recklessly not caring whether the allegation, which it affirmed
as of its own knowledge to be true, was true or false, and,
being false, its conduct was a fraudulent attempt to confer
jurisdiction upon the court, where none existed.
Myron M. Navison Shoe Co., Inc. v. Lane Shoe Co., 36 F.2d 454, 459 (1st Cir. 1929)
(petitioner had received a list of thirty creditors of the alleged debtor just prior to filing its
petition); see In re Crown Sportswear, Inc., 575 F.2d at 993-94; Manning v. Evans, 156 F.
106 (D.N.J. 1907) (only one creditor filed when it was aware that three creditors were
needed); see generally J. Moore, 3 Collier on Bankruptcy, ¶ 59.30, at 647-48 (14th ed.
1977):
The courts, however, have clearly indicated that intervention
. . . will not be permitted as a means of improperly conferring
jurisdiction upon the bankruptcy court. It may happen that
creditors, fully knowing that they are estopped from filing a
petition, or that they do not constitute the required number or
do not have the requisite amount of claims, may, in defiance
of such knowledge, file a petition alleging facts to show that
creditors sufficient in number and amount of claims have
joined in the petition, in the hope that in the course of the
proceeding other creditors will intervene . . . and save the
petition. Under such circumstances, it is evident that the court
may properly dismiss the petition and deny the creditors the
right to intervene . . . .
(footnotes omitted).
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20
In general, when evaluating whether an involuntary petition was properly
filed and meets the requirements of section 303, “[g]ood faith is presumed and the debtor
has the burden of proving bad faith by a preponderance of the evidence.” In re Ballato,
252 B.R. 553, 558 (Bankr. M.D. Fla. 2000); see also In re Crown Sportswear, Inc., 575
F.2d at 993. In this instance, Mylotte has the burden to demonstrate that Mr. Hanselmann
“knew or should have known that [Mylotte] had more than 12 creditors” when he filed
the involuntary bankruptcy petition in March 2007. In re R&A Business Associates, Inc.,
1999 WL 820859, at *2; see 2 Collier on Bankruptcy, ¶ 303.09[1] at 303-70 to 71:
[T]he Bankruptcy Code prescribes no fixed standard [for bad
faith], although the current trend is to adopt a standard that
incorporates both objective and subjective elements. This
means that if the petitioning creditor knew or should have
known that the debtor had 12 or more creditors, a filing with
fewer than the requisite number is improper, resulting in case
dismissal rather than joinder. For example, a creditor cannot
ignore the results of an investigation the creditor conducts.
Nor can the petitioning creditor conduct an investigation in a
manner that it knows will yield incomplete information.
Good faith can be found lacking when the debtor is of such a
size that any reasonable person would have known that the
alleged debtor probably had 12 or more creditors.
(footnotes omitted); see also In re Crown Sportswear, Inc., 575 F.2d at 994; In re Claren,
Inc., 1992 WL 346779, at *1-*2 (E.D. Pa. 1992):
If a single creditor files an involuntary petition knowing the
debtor has more than twelve creditors, the petition must be
dismissed. Basin Elec. Power Co-Op. v. Midwest Processing
Co., 769 F.2d 483, 486 (8th Cir.1985), cert. denied, 474 U.S.
1083 (1986). If, however, the petition was filed in good faith,
the bankruptcy court should allow a reasonable time for other
creditors to join the petition. Id. See also Bankruptcy Rule
1003(d).
Bad faith has been defined as The [sic] opposite of “good
faith,” generally implying or involving actual or constructive
fraud, or a design to mislead or deceive another, or a neglect
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21
or refusal to fulfill some duty or some contractual obligation,
not prompted by an honest mistake as to one's rights or duties,
but by some interested or sinister motive. [The] [t]erm “bad
faith” is not simply bad judgment but rather it implies the
conscious doing of a wrong because of dishonest purpose or
moral obliquity; it is different from the negative idea of
negligence in that it contemplates a state of mind
affirmatively operating with design or ill will.
(citing In re Elsinore Shore Associates, 91 B.R. 238 (Bank. D.N.J. 1988)).
Based upon the evidence presented, I conclude that Mr. Hanselmann knew
or should have known that Mylotte had twelve or more creditors when he filed this
involuntary petition.
His information sources were Mylotte’s financial records in January 2006;
testimony about various creditor claims at that time; docket entries of civil actions
involving Mylotte; a business credit report about Mylotte; a letter from Mr. Edward David
in February 2007; and a copy of the receivership motion filed by the City of Philadelphia
in March 2007. From these sources, Mr. Hanselmann concedes that as of March 23,
2007—the date of his involuntary petition—he was aware that creditors of Mylotte, in
addition to himself, included the City of Philadelphia, Arden Seven Penn Partners, B&R
Services, Esquire Reporting Services and Wilmington Trust. In addition to these five
creditors and himself though, he had been informed in January 2006 that Mylotte was
behind in withholding tax payments to the IRS, owed funds to three law firms—Kolsby
Gordon; Masterson Braunfeld; and DiDonato & Winterhalter—had not paid its moving
company, Graebel, since 2005, was delinquent in credit card payments to MBNA, was
making small monthly payments to AIG on a $50,000 claim, had been sued by Document
Technologies, and had an outstanding obligation to its premium finance company. He
had also seen a list of vendor payables as of January 2006.
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Mr. Hanselmann also testified that the state court trial judge at the January 20066
hearing had dismissed Mylotte’s aged payables report as “useless,” and therefore Mr.
Hanselmann felt justified in ignoring it for purposes of filing an involuntary petition. However,
from my review of the January 2006 hearing transcript, Ex. A-2, the state court judge never
disparaged the aged payables report. Instead, the judge posed questions to Mr. David about the
firm’s “monthly operating ledger,” id., N.T. at 54-55, a completely different document. The
court had just been informed that equity partner draws were not included in the operating ledger.
Id., N.T. at 56. At that point, the court remarked:
All right. Well, when I see operating expenses and total revenue, I
guess it’s — I mean, to me, it’s a useless document I guess in that
regard.
Id., N.T. at 56.
I do not interpret that comment as opining that the aged receivables listing, which
was a completely different document at that hearing, was of no value in assessing the financial
condition of the law firm. Rather, the state court judge was concerned that the equity partners
were drawing out firm funds for personal expenses from which Mylotte may have been able to
pay court imposed sanctions, and there was no record about the amounts of such draws.
22
After January 2006, Mr. Hanselmann learned that certain judgments had
been entered against Mylotte, and that the firm had ceased its operations. He also had an
Equifax credit report that reflected information sent to that credit reporting agency from
four unnamed creditors, stating that Mylotte was current in its payments to those
creditors. It is highly unlikely that those four unnamed creditors, reporting that Mylotte
was current in payments to them, would have included taxing authorities, or those
creditors that had brought suit against Mylotte, or those creditors who had outstanding
receivables dating from January 2006 or earlier.
Mr. Hanselmann testified that he believed that all of the vendor creditors
had stale claims and so were not qualified creditors under section 303(b). Although that6
document was not offered in evidence in this contested matter, the hearing transcript from
January 2006, Ex. A-2, reveals that this payables ledger included $358,000 in debts,
excluding taxing authority claims. Id., N.T. at 16. Included therein were recent
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Indeed, subsection 303(l) was added in 2005 to protect individuals who are7
subjected to improper involuntary petitions. As Mylotte is a partnership, that subsection is not
applicable.
23
obligations to AIG, Arden Seven Penn Partners, law firm creditors and MBNA, among
others. Id. N.T. at 18, 20-21. Thus, it was not likely that this entire listing would consist
of only very old obligations that the firm had no liability to pay. And it was unreasonable
of Mr. Hanselmann to ignore those creditors, as well as many others mentioned at the
hearing, or to assume that they had been paid in full by March 2007. Indeed, the firm
ceased operations because it could not pay its debts, and Mr. Hanselmann knew it.
In sum, Mr. Hanselmann, in the course of his litigation with Mylotte, delved
into the financial affairs of the law firm and received considerable information about its
finances. As of March 2007, he knew or should have known that Mylotte had a least
twelve creditors whose claims were not subject to bona fide dispute.
On one hand, involuntary petitions are favored because they can prevent the
diminishment of assets by a debtor and provide equality of treatment among creditors.
See In re Elsub Corp., 70 B.R. 797, 813 (Bankr. D.N.J. 1987). On the other hand, the
filing of an involuntary petition is a powerful tool in a creditor’s arsenal, due to its
potential to greatly harm the debtor. After the petition is filed, a debtor may lose its right
to transfer or use assets; it may be denied further credit; it may suffer great
embarrassment. See In re Morris, 115 B.R. 752, 757 (Bankr. E.D.N.Y. 1990). Thus, it is
a weapon that may easily be misused and constraints to insure its proper application are
necessary. See In re Dino’s, 183 B.R. at 783-84.7
This places in conflict the congressional desire “to facilitate bankruptcy
proceedings regardless of the correctness of the originating petition,” In re Crown
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24
Sportswear, Inc., 575 F.2d 991, 993 (1st Cir. 1978), with a desire not to permit one
creditor to initiate a process requiring three creditors, and in so doing “circumvent unduly
the three creditor requirement of section 303(b).” Basin Elec. Power Co-op. v. Midwest
Processing Co., 769 F.2d at 486. The resolution of this conflict which most fairly
balances these competing policies and which comports with likely congressional intent
requires a determination whether the original, single petitioner knew or should have
known that the debtor had twelve or more qualified creditors and so acted in bad faith in
its filing of the involuntary petition alone.
Since Mr. Hanselmann knowingly ran afoul of section 303(b)(1), the
joinder requests of the four other creditors must be denied and this involuntary petition
will be dismissed, albeit without prejudice to those joinder creditors filing their own
petition if they so choose. See generally Matter of Smith Ave. Contractors, Inc., 59 B.R.
137 (Bankr. D.N.J. 1986). Furthermore, Mylotte’s answer requests relief under 11 U.S.C.
§ 303(i), necessitating a further hearing.
An appropriate order shall be entered.
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UNITED STATES BANKRUPTCY COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
In re : Chapter 7
MYLOTTE, DAVID & FITZPATRICK :
Debtor : Bankruptcy No. 07-11861bif
.................................................
ORDER
.................................................
AND NOW, this 12th day of July 2007, for the reasons stated in the
accompanying memorandum, it is hereby ordered that:
1. The joinder requests of Arden Seven Penn Partners, L.P., Graebel
Companies, Inc., Summit Court Reporting, Inc., and Sir Lancellot Courier and Delivery
Service is denied;
2. The involuntary petition filed by Mr. Frederick C. Hanselmann is
dismissed because it does not comply with 11 U.S.C. § 303(b)(1);
3. An evidentiary hearing shall take place on August 24, 2007 at 9:30 a.m.
in Bankruptcy Courtroom #2 to determine, what relief if any, the putative debtor is
entitled to receive under section 303(i).
____________________
BRUCE FOX
United States Bankruptcy Judge
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copies to:
Mr. Fredrick C. Hanselmann
117 Forrest Avenue, Suite 217
Narberth, PA 19072
Albert A. Ciardi, III, Esquire
Dimitri L. Karapelou, Esquire
Ciardi & Ciardi, P.C.
One Commerce Square
2005 Market Street, Suite 2020
Philadelphia, PA 19103
Robert Tyler Tomlinson, Esquire
Liederbach Huhn Foy Van Blank & Thompson
892 Second Street Pike, Suite C
Richboro, PA 18954
Mr. Anthony Klondar
Sir Lancellot Courier and Delivery Service
223 South Governor Prince Blvd
Essington, PA 19029
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