The University of Texas School of Law

Presented: 2012 Jay L. Westbrook Bankruptcy Conference

November 8 -9, 2012 Austin, Texas

Involuntary Petitions: a Weapon in the Right or Wrong Hands

Michael P. Cooley AKIN GUMP STRAUSS HAUER & FELD LLP 1700 Pacific Avenue, Suite 4100 Dallas, Texas 75201-4624 [email protected]

Jay H. Ong MUNSCH HARDT KOPF & HARR, PC Frost Bank Tower 401 Congress Avenue, Suite 3050 Austin, Texas 78701-4071 [email protected]

Continuing Legal Education • 512-475-6700 • www.utcle.org Error! Unknown document property name.

I. INTRODUCTION1

The concept of initiating a bankruptcy case against an entity, through the filing of an “involuntary” petition against the putative debtor, is nothing new. In fact, involuntary bankruptcy cases predate voluntary bankruptcy cases entirely – by nearly three centuries – having first arisen under “An act against such persons as do make bankrupts,” enacted in England in 1542, and under which a bankruptcy case could only be initiated by creditors against subject debtors.2

Today, Section 303 of the Bankruptcy Code, and its provisions governing the processes for filing, litigating and administering involuntary petitions, are well known – at least generally – to the average bankruptcy practitioner, having undergone only minor changes since its enactment in 1978.3 That this familiarity is the product of the enduring structure of the statute, more so than any particular historical significance or experience with involuntary cases, is supported by the small fraction that such cases historically comprise of the overall volume of bankruptcy cases. In recent history, from 2000 through 2005, the year in which the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was enacted, filing rates across all chapters of the Bankruptcy Code steadily increased, rising from approximately 1,262,101 annual filings in 2000, to approximately 1,782,080 in 2005.4 During this same period, the total volume of involuntary cases commenced throughout the nation steadily decreased from only 729 cases in 2000, to only 563 involuntary cases in 2005, and the percentage of involuntary cases relative to the total volume of bankruptcy cases at this time averaged only approximately 0.048%.5 Not only was the rate of involuntary cases diminishing during this period despite that bankruptcy filing rates were increasing generally, it also never exceeded 0.058% of the total volume of bankruptcy cases filed in any given year.

At the time of BAPCPA's enactment, the general perception was that it largely had the effect of making bankruptcy more cumbersome, more expensive, and somewhat less effective in discharging debt obligations.6 This perception leads to a corollary that bankruptcy is

1 The authors gratefully acknowledge the assistance of J. Machir Stull, Akin Gump Strauss Hauer & Feld, LLP, for his indispensable contributions to these materials. 2 Prof. Charles J. Tabb, The History of the Bankruptcy Laws in the United States, 3 Am. Bankr. Inst. L. Rev. 5, *8-9 (1995). 3 See 11 U.S.C.A. § 303 note (Thomson Reuters West, Westlaw through P.L. 112-174) (Historical and Statutory Notes). 4 See http://www.uscourts.gov/Statistics/JudicialFactsAndFigures/JudicialFactsAndFigures2005.aspx (last visited October 1, 2012). The lone exception being 2003-2004 during which annual filings decreased from 1,661,996 in 2003 to 1,618,987 in 2004. 5 Id.; John E. Sullivan III, Asset Protection Plans & Bankruptcy: Some Possible Issues, VMF0616 ALI-ABA 73, 82 (June 16, 2005). Again, we see a minor outlier here, from 2000-2001, when the rate of involuntary cases jumped from 729 total cases, to 797 cases. 6 See, e.g., Richard S. Gendler, Categorizing Tax Liabilities for the Applicability of the Means Test, 31 Am. Bankr. Inst. J. 18 (August 2012) (“…[BAPCPA] was the result of successful creditor lobbyist arguments that the increasing number of American bankruptcy filings in recent decades was a result of a decline in the nation's financial responsibility.”); Teresa A. Sullivan et al., Less Stigma or More Financial Distress: An Empirical Analysis of the Extraordinary Increase in Bankruptcy Filings, 59 Stan. L. Rev. 213, 214 (2006) (alleging that BAPCPA has made bankruptcy filings more difficult, or even impossible, for many debtors); John E. Sullivan, supra note 4, at 99-101.

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consequently less attractive as a financial restructuring tool. These same considerations are typically raised to explain the peak of bankruptcy case filings in 2005, and subsequent precipitous drop in the volume of cases in 2006, as many potential debtors rushed to file their cases before BAPCPA would take effect.7

Notwithstanding, a confluence of recent systemic trends seems to now be bringing involuntary cases slowly to the fore. Since BAPCPA, the aggregate filing rate of bankruptcy cases that nationally had dropped precipitously in 2006, began rising again beginning in late 2007, and even more sharply in 2008 – commensurate with the unprecedented collapse of the international economy that year.8

Along with them, the rate of filing of involuntary cases has also increased, but in fact, at a considerably greater rate than filing rates for bankruptcy cases generally. The volume of annual bankruptcy case filings nationally increased from 2006 through 2010 by a factor of over 30%, but during this same time period, the incidence of involuntary bankruptcy cases more than doubled (with an aggregate increase of 54%).9 The basic theory for this statistical trend is essentially that, while the softening of the economy over the past five years has definitely led to a greater need for bankruptcy relief, the decreasing perception of bankruptcy as a cost effective restructuring tool has led more and more would be debtors to refuse to consider it as a viable option.10 This, in turn, has raised the prominence of involuntary petitions in bankruptcy

7 See, e.g., Matthew D. Pechous, Walking the Tight Rope and Not the Plank: A Proposed Standard for Second-Level Appellate Review of Equitable Mootness Determinations, 28 Emory Bankr. Dev. J. 547, 547 n. 2 (2012) (attributing the high volume of bankruptcy cases filed during the "benchmark" year of 2005, to a rush by the masses to the courthouse in order to file their cases before BAPCPA would take effect.); Ed Flynn et al., Chapter 11 Filing Trends in History and Today, 28 Am. Bankr. Inst. J. 14, 15 (May 2009) (attributing a surge of filings in 2005 and corresponding dearth of filings in 2006 to the intervening effectiveness of BAPCPA). 8 See, e.g., Ed Flynn et al., Chapter 11 Filing Trends in Bankruptcy, 2007-11, 30 Am. Bankr. Inst. J. 12 (November 2011) (discussing soaring filing rates from 2007 through 2009, followed by a leveling off in 2010 and further reduction in filing rates in 2011); James Winston Kim, Saving Our Future: Why Voluntary Contributions to Retirement Accounts are Reasonable Expenses, 26 Emory Bankr. Dev. J. 341, 354 (2010) (discussing economic down turn in 2008 and corresponding increase in bankruptcy filings of 29% over 2007). 9 See http://www.uscourts.gov/Statistics/JudicialFactsAndFigures/JudicialFactsAndFigures2010.aspx (last visited October 1, 2012). 10 See, e.g., Katherine Porter, The Pretend Solution: An Empirical Study Of Bankruptcy Outcomes, 90 Tex. L. Rev. 103, 126-27 (November 2011) (discussing the mixed results obtained by bankruptcy debtors under the current structure of national consumer bankruptcy laws); Alistaire Bambach, The SEC in Bankruptcy: Past, Present and Future, 18 Am. Bankr. Inst. L. Rev. 607, 611-614 (Winter, 2010) (discussing SEC v. Byers, 609 F.3d 87 (2d Cir. 2010) and the use of equity receiverships by the Securities and Exchange Commission and federal judiciary as an alternative to bankruptcy); Robert K. Scheinbaum, Suggested Reading – Strategic Alternatives for Distressed Businesses, Second Edition, 30 Am. Bankr. Inst. J. 52 (February 2011); Vinay Chopra, Too Late for a Fresh Start: Why the Bankruptcy Code Should Exclude Continuing Care Retirement Communities, 27 Emory Bankr. Dev. J. 71, 91-92 (2010) (advocating that Connecticut's state law receivership regime is a superior alternative to bankruptcy for continuing care retirement communities). In SEC v. Byers, the Second Circuit Court of Appeals held that federal district courts had the authority under SEC receiverships to issue litigation injunctions that would encompass prohibitions against filing bankruptcy petitions, including the filing of involuntary petitions by creditors. SEC v. Byers, 609 F.3d. at 91-92. The court added that: An anti-litigation injunction is simply one of the tools available to courts to help further the goals of the receivership…In this litigation the receivership must manage hundreds of…entities that sprawl across the

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First appeared as part of the conference materials for the 31st Annual Bankruptcy Conference session "Involuntary Petitions: A Weapon in the Right or Wrong Hands"