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Judge Silverstein Denies a Motion to Bar Joinder in an Involuntary Petition Where the Alleged Debtor Failed to Prove the Original Petition was Filed in Bad Faith

By Charlene D. Davis

On September 12, 2016, Judge Laurie S. Silverstein of the United States Bankruptcy Court for the District of Delaware (the “Court”) issued an order and opinion in connection with an involuntary Chapter 7 petition (the “Involuntary Petition”) filed against Luxeyard, Inc (“Luxeyard”), denying Luxeyard’s motion to bar certain parties (the “Joining Petitioners”) from joining in the Involuntary Petition (the “Bar to Joinder Motion”). The basis of the motion was the judicially created “bar to joinder” doctrine. The Joining Petitioners and one remaining original petitioner (the “Objectors”) opposed the Bar Joinder Motion arguing that the bar to joinder doctrine is bad law and that Luxeyard failed to satisfy its evidentiary burden under the doctrine. The Court’s decision to deny the Bar to Joinder Motion was based on Luxeyard’s inability to meet its burden to show that the Involuntary Petition was filed in bad faith; a conclusion necessary to invoke the bar to joinder doctrine.

Against the backdrop of disputes, litigation and other bankruptcy filings, Jinsun, LLC, Equity Highrise, Inc., Sun Bear, LLC and Lee Bear I, LLC (the “Original Petitioners”) filed the Involuntary Petition against Luxeyard in September 14, 2014. By the time that the Bar to Joinder Motion was filed on February 1, 2016, three of the four Original Petitioners had withdrawn as petitioners as a result of a settlement in certain litigation, but the Joining Petitioners had filed joinders in the Involuntary Petition. Luxeyard argued that the Court should bar the Joining Petitioners from joining in the Involuntary Petition because it was filed in bad faith and for an improper purpose. The Objectors argued that the doctrine, which has not been adopted by the Third Circuit, is bad law and inapplicable or, alternatively, the Involuntary Petition was not filed in bad faith.

In rendering its decision, the Court noted that, pursuant to section 303 of the Bankruptcy Code, the three prerequisites for filing an involuntary case against a debtor with at least 12 creditors are (1) there must be 3 or more petitioning creditors; (2) each petitioning creditor must hold a non-contingent, undisputed claim and (3) the claims must aggregate at least $15,775 more than the value of liens on the debtor’s property.  If the debtor challenges the involuntary petition, the Court must determine that the debtor is generally not paying its debts as they become due. The Court also observed that section 303 provides for the joinder of creditors in the involuntary petition as of right but that some courts have developed the bar to joinder doctrine to address the potentially troubling scenario where a petition is deficient as originally filed and cured by the addition of a joining creditor. The Court reviewed cases cited by the parties (and additional opinions) to conclude that courts have applied the doctrine in one type of bad faith filing contest, to wit, when a petitioner knows at the time of filing that the petition does not satisfy the prerequisites of section 303 of the Bankruptcy Code. The Court also concluded that application of the doctrine in such circumstances is consistent with the purpose of the doctrine which is to protect the integrity of the statutory prerequisites.

The Court then examined the evidentiary record before it, utilizing the Third Circuit’s “totality of the circumstances” standard to determine whether Luxeyard had proven that the Involuntary Petition was filed in bad faith. After examining each of the factors in the totality of the circumstances test, the Court concluded that Luxeyard failed to prove by a preponderance of the evidence that the Involuntary Petition was filed in bad faith and, as a result, it would not bar the Joining Petitioners from joining in the Involuntary Petition.

A copy of the Court’s opinion is available here.

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