The Bankruptcy Hotline

'Bona Fide Dispute' Should Be Determined ASAP in Involuntary Filing

The Second Circuit has held that a bankruptcy court's determination that a debt is the subject of a 'bona fide dispute' under the Bankruptcy Code should be made as soon as possible in an involuntary proceeding. Key Mechanical Inc. v. BDC, 56 LLC, 02-5029 (May 21).

Section 303(b), states that an involuntary case against a debtor is commenced when three or more entities have a claim 'that is not contingent as to liability or the subject of a bone fide dispute.' The timing for this determination, however, has divided courts, with some judges finding the question should be decided immediately, and others allowing the question to be resolved later in the proceedings.

Electing to adopt a more timely approach, the Second Circuit stated that 'the more sound view is that the requirement is subject matter jurisdictional.' The court reasoned that '[w]hether an alleged debtor is properly before the bankruptcy court in an involuntary case is a threshold determination that should be made at the earliest possible stage of the proceedings.' The court relied on a test formulated by the Seventh Circuit in In re Busick, 831 F.2d 745 (1987), which stated that a 'bankruptcy court must determine whether there is an objective basis for either a factual or a legal dispute as to the validity of the debt.' The Second Circuit chose to adopt this objective test, 'as well as the burden-shifting framework developed by other courts for its application, which requires, first, that the petitioning creditor establish a prima facie case that no bona fide dispute exists.' Upon establishing that a prima facie case has been established, the burden then shifts to the debtor to demonstrate the existence of a bone fide dispute. The court reasoned that if a creditor was not required to establish a true dispute 'at the earliest practical point' then a creditor 'could, on the basis of relatively untested claims, haul a solvent debtor with whom they have legitimate disputes into bankruptcy court and force it to defend an involuntary proceeding while the bankruptcy court leaves for a later merits determination whether the debtor is even properly before it.'

'Bona Fide Dispute' Should Be Determined ASAP in Involuntary Filing

The Second Circuit has held that a bankruptcy court's determination that a debt is the subject of a 'bona fide dispute' under the Bankruptcy Code should be made as soon as possible in an involuntary proceeding. Key Mechanical Inc. v. BDC, 56 LLC, 02-5029 (May 21).

Section 303(b), states that an involuntary case against a debtor is commenced when three or more entities have a claim 'that is not contingent as to liability or the subject of a bone fide dispute.' The timing for this determination, however, has divided courts, with some judges finding the question should be decided immediately, and others allowing the question to be resolved later in the proceedings.

Electing to adopt a more timely approach, the Second Circuit stated that 'the more sound view is that the requirement is subject matter jurisdictional.' The court reasoned that '[w]hether an alleged debtor is properly before the bankruptcy court in an involuntary case is a threshold determination that should be made at the earliest possible stage of the proceedings.' The court relied on a test formulated by the Seventh Circuit in In re Busick, 831 F.2d 745 (1987), which stated that a 'bankruptcy court must determine whether there is an objective basis for either a factual or a legal dispute as to the validity of the debt.' The Second Circuit chose to adopt this objective test, 'as well as the burden-shifting framework developed by other courts for its application, which requires, first, that the petitioning creditor establish a prima facie case that no bona fide dispute exists.' Upon establishing that a prima facie case has been established, the burden then shifts to the debtor to demonstrate the existence of a bone fide dispute. The court reasoned that if a creditor was not required to establish a true dispute 'at the earliest practical point' then a creditor 'could, on the basis of relatively untested claims, haul a solvent debtor with whom they have legitimate disputes into bankruptcy court and force it to defend an involuntary proceeding while the bankruptcy court leaves for a later merits determination whether the debtor is even properly before it.'