Nevada District Court Holds that a Creditor Must Have a Fully Undisputed Claim to Petition for an Involuntary Bankruptcy

by Kramer Levin Naftalis & Frankel LLP

Kramer Levin Naftalis & Frankel LLP

The Bottom Line

The Nevada District Court recently held, in Mont. Dept. of Revenue v. Blixseth, No. 13-cv-01324-JAD, 2017 WL 6417632 (D. Nev. 15, 2017), that a creditor must have a fully undisputed claim to be a “qualified creditor” that may petition for an involuntary bankruptcy.  The Court found that the 2005 amendments to the Bankruptcy Code overruled existing Ninth Circuit precedent that had allowed a creditor to maintain an involuntary petition if at least a portion of its claim was undisputed and the other requirements were met.  When seeking qualified petitioning creditors, this narrows the field of eligible co-petitioners.

What Happened?

Section 303 of the Bankruptcy Code allows creditors to commence an involuntary bankruptcy petition against an individual or other entity if certain requirements are met.  One of those requirements is that the petitioning creditor or creditors hold a claim “that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount . . . .”  11 U.S.C. § 303(b)(1).  In Blixeth, several state taxing authorities had commenced an involuntary bankruptcy case against an individual over alleged unpaid taxes.  The individual moved to dismiss the case arguing that the tax claims were subject to a bona fide dispute as to the amount.  The bankruptcy court granted the motion and the district court affirmed.

In opposition to the motion to dismiss, the Montana Department of Revenue (“Montana”) argued that the alleged debtor was only disputing a portion of the claim.  The Ninth Circuit had previously held that a dispute over the amount of the claim was not a “bona fide dispute” so long as some portion of the claim was undisputed.  See, e.g., In re Focus Media, Inc., 378 F.3d 916, 925-26 (9th Cir. 2004).  However, this precedent was based on an older version of the statute.  Prior to 2005, the statute only excluded claims that were “the subject of a bona fide dispute” without specifying liability or amount.  See Blixseth, 2017 WL 6417632 at *10. 

The district court held that the amended language effectively overruled the prior precedent.  After first finding that Montana’s claim and a similar claim by the California Franchise Tax Board were subject to legitimate disputes for at least a portion of the amount, the Court reviewed the history of the statute.  The original version did not exclude disputed claims.  In 1984, Congress added the “bona fide dispute” provision.  In 2005, Congress further amended the statute to the current language.  The district court noted that several bankruptcy courts had found that this revision overruled prior precedent.  The First and Fifth Circuits had also held that any legitimate dispute over the amount of the claim was sufficient to disqualify the entire claim, even if a portion was undisputed. 

Despite this, some courts still held that a dispute over only a portion of the claim did not make it the subject of a bona fide dispute.  Looking to the legislative history, these courts had held that the “liability or amount” language was only a clarification as the original “bona fide dispute” provision was intended to address disputes about the liability or amount of the claim.

The district court rejected this argument noting that the plain language of the current statute was unambiguous.  An inquiry into legislative history is only appropriate when the statute is ambiguous.  The court found that the plain language of the statute meant that any legitimate dispute as to any portion of the amount of the claim created a “bona fide dispute as to liability or amount.”  Since the language was clear and unambiguous, the inquiry was at an end.

Montana attempted to argue that such a literal interpretation of the statute would lead to an absurd result:  a creditor with a $100,000 claim could be disqualified entirely if just $100 of the claim was disputed.  Blixseth, 2017 WL 6417632 at *13.  The court rejected this argument holding that the well-established purpose of the bona fide dispute provision was to prevent creditors from using involuntary bankruptcy as a debt collection device.  The Bankruptcy Code serves the dual purposes of ensuring an orderly administration of creditors’ claims and protecting debtors from coercive tactics.  Disqualifying a $100,000 claim due to a $100 dispute may be a harsh result, but it is not an absurd result given the purpose of the statute.

Why This Case is Interesting

Involuntary bankruptcy cases can be a powerful tool for creditors, and this decision raises the bar for use.  Creating a legitimate dispute over the amount of a claim may not be difficult for certain debtors.  For example, disputes over whether a default interest rate should be applied could potentially disqualify a claim even when the principal amount owed is undisputed.  While this “overruling” has yet to be confirmed by the Ninth Circuit, creditors seeking to commence an involuntary bankruptcy will want to take steps to ensure their claims are not subject to a bona fide dispute.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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