Liberty Tool, & Manufacturing v. Vortex Fishing Systems, Inc.
Docket: No. 00-15259
Court: Court of Appeals for the Ninth Circuit; August 28, 2001; Federal Appellate Court
An ousted business partner attempted to initiate an involuntary bankruptcy against Vortex Fishing Systems to gain a business advantage, prompting the court to establish the criteria for determining whether a dispute is 'bona fide' under 11 U.S.C. 303. The court adopted an objective test used by other circuits and affirmed the Bankruptcy Appellate Panel's dismissal of the petition. Ray Scott and Wes Higgins formed Vortex in 1990, with Scott initially as a minority shareholder. After becoming more involved due to lack of profits, Scott became the majority shareholder by 1994. Vortex had significant debts when Scott took over but made progress in repaying them after relocating the company to Arizona. Higgins and businessman Rodger Ford began exploring involuntary bankruptcy after failing to negotiate a sale of Vortex. To file an involuntary bankruptcy petition, at least three creditors with non-disputed claims were required, which led to Higgins acquiring claims from two creditors and contacting others to participate in the petition. Initially filed on January 25, 1999, the petition included four creditors but faced withdrawal and subsequent motions to join. Ultimately, the Bankruptcy Court dismissed the petition on May 5, 1999, concluding that the claims were disputed and not bona fide, while also noting that Vortex was paying its debts as due.
The Bankruptcy Appellate Panel (BAP) upheld the Bankruptcy Court's dismissal of an involuntary bankruptcy petition, affirming that Byron-Lambert's claim was appropriately dismissed and that the claims of Liberty Tool, Vortex Lures, Viking, and the Vincents were subject to bona fide disputes. The BAP recognized Witchcraft Tape Products as a valid petitioning creditor but deemed any oversight regarding Telenational Marketing's motion for joinder harmless, as Telenational had declared it did not join the petition. Additionally, the BAP confirmed that Bankruptcy Rule 1003(b) did not mandate notice to Vortex's other creditors and supported the Bankruptcy Court's finding that Vortex was generally meeting its debt obligations.
On appeal, the reviewing court applies a de novo standard for legal conclusions and clear error for factual conclusions. The court acknowledged that the standard of review for determining a "bona fide dispute" under 11 U.S.C. § 303 is a factual inquiry, adopting a clearly erroneous standard, consistent with other circuits. The appeals court noted that for involuntary bankruptcy petitions, at least three creditors with non-disputed claims must collectively exceed $10,775, with the burden of proof resting on the petitioning creditors to demonstrate the absence of bona fide disputes. The BAP adopted an "objective test" for evaluating bona fide disputes, requiring either genuine factual issues regarding the debtor's liability or valid legal contentions regarding undisputed facts, which necessitated the petition's dismissal if such disputes existed.
The excerpt addresses the legal standards for evaluating claims in bankruptcy proceedings, specifically rejecting a subjective good faith standard in favor of an objective test for disputes concerning liability or claim amounts. Byron-Lambert, the only initial petitioning creditor whose claim Vortex did not dispute, requested to withdraw from the involuntary petition shortly after it was filed, citing discrepancies in the representations made. The Bankruptcy Court granted this withdrawal, and Byron-Lambert subsequently did not participate in the case.
The appellants argued that the Court erred by allowing Byron-Lambert's withdrawal, claiming it affected the sufficiency of the involuntary petition. However, the Bankruptcy Appellate Panel (BAP) noted that this argument misapplied policy considerations and highlighted a long-standing rule that a debtor's payments to petitioning creditors do not affect the court's jurisdiction. The BAP also pointed out that withdrawal based on misunderstandings does not trigger the same policy concerns as cases where creditors withdraw to defeat a petition.
The case of In re Molen Drilling Co. was cited, where a withdrawal would have undermined a significant claim due to insufficient petitioners. In contrast, in the current case, the remaining creditors still met the requirement for a valid petition. The Bankruptcy Court acted within its discretion in permitting Byron-Lambert's withdrawal, as it could have reasonably assumed the remaining claims were bona fide at the time.
Liberty and Vortex's predecessors did not present new arguments on appeal regarding Liberty's claim against Debtor Vortex, which involves an open account with 17 outstanding invoices totaling $39,083.48. Debtor had acknowledged payment delays in correspondence between 1994 and 1995 and had commissioned a mold from Liberty for $17,475, which was never completed. Following a complaint by Liberty in 1996, Debtor counterclaimed, denying any debts and asserting various affirmative defenses including impossibility of performance and waiver. The bankruptcy court found Liberty's claim subject to a bona fide dispute based on ongoing litigation and unresolved factual issues regarding the mold contract's relation to the open account. Petitioning Creditors argued that the court overlooked Debtor's admissions about the account balance and that the counterclaim was unrelated to the open account. However, the court maintained that the existence of litigation or a counterclaim does not automatically negate a bona fide dispute. It concluded that sufficient evidence supported the finding of a bona fide dispute concerning Liberty's claim, given Debtor's defenses and the context of their agreement.
Liberty deferred any outstanding debt from Debtor until certain earnings were achieved from a mold's completion, with a $2,000 monthly payment requirement postponed. Debtor claimed that Liberty's failure to complete the mold made performance impossible and constituted a waiver of payment terms. A February 28, 1996 letter from Scott indicated that Liberty acknowledged the delay in the mold's completion and that Debtor would not meet its payment obligations, suggesting a bona fide dispute regarding Liberty's claim. The bankruptcy court found that Liberty's breach might have waived its right to collect on the account, supporting the notion that its claim was legitimately disputed.
In a separate matter involving Vortex Lures and Higgins, a Vortex Agreement was executed to form a corporation for marketing fishing lures, with liabilities assumed under royalty agreements. A June 14, 1994 letter indicated a need to resolve obligations related to Higgins' debt. Higgins' claim was based on a 1985 agreement for asset purchase from Viking Lures, which believed it was owed $200,000 from Vortex Lures, collectable from Debtor as its successor. The bankruptcy court found a bona fide dispute over the applicability of Texas or Montana statutes of limitations, the timing of when the statute began to run, and Debtor's liability due to the lack of formal approval of the Vortex Agreement by Debtor. Petitioning Creditors argued that the Vortex Agreement legally bound Debtor, governed by Montana law, with an eight-year statute of limitations that could be tolled by written acknowledgment of the debt.
Petitioning Creditors argue that Scott's acknowledgment of objections in the June Letter tolls the statute of limitations, asserting the court erred in finding their claims were subject to a bona fide dispute. However, it is noted that the evidence does not clearly indicate that the Debtor accepted liability for these claims under the Vortex Agreement, which only pertains to royalty agreements for Viking Lures and Vortex Lures, and does not include the 1985 Agreement referenced by Higgins. Furthermore, the claims related to the Utex Agreement, which mandated Utex to pay Higgins 5% of gross sales until a total of $109,500 was reached, raise questions regarding its applicability. The Utex Agreement ended in 1988 when Utex ceased manufacturing, leading the Debtor to dispute any owed payments. Consequently, the court could logically find that claims from Vortex Lures and Higgins were bona fide disputes.
The applicable statute of limitations is contentious due to disagreements about liability sources. Federal choice of law rules apply in bankruptcy cases, indicating Texas law may govern if the claims arise from the Utex Agreement. Under Texas law, actions must be initiated within four years from when the cause of action accrues. Even if the June Letter is seen as an acknowledgment, the claims would still be time-barred as the statute would have expired by June 1998, while the Petition was filed in 1999. If the claims do not pertain to the Utex Agreement, Arizona's choice of law rules would dictate the applicable statute of limitations, which generally favors the forum’s statute unless significant relationships with another state warrant otherwise.
Montana law allows an eight-year statute of limitations on debts, which can restart if there is a written acknowledgment signed by the liable party. If the June Letter qualifies as such an acknowledgment, Vortex Lures and Higgins' claims would not be time-barred, beginning anew from June 14, 1994. Conversely, Arizona law imposes a six-year limit, also subject to renewal upon written acknowledgment. The court found no clear error in determining that Vortex Lures and Higgins' claims were subject to a bona fide dispute regarding the applicable statute of limitations and Debtor's liability under corporate law. Under the Restatement (Second) of Conflicts of Laws, the choice between Montana law (the state of incorporation) and Arizona law (the forum state) is pertinent. Montana law states that a corporation may be bound by contracts entered by promoters if the corporation later acknowledges or benefits from them. However, a corporation must act in its corporate capacity to be held liable. Arizona law similarly supports this principle, allowing for binding agreements made by promoters if the corporation adopts them. The court noted the absence of corporate minutes or resolutions ratifying the Vortex Agreement, leaving the question of Debtor's ratification—either express or implied—in bona fide dispute. Additionally, the claims of other creditors, Vincents, Witchcraft Tape Products, and Telenational Marketing, totaling $9,520.26, are insufficient to meet the $10,775 threshold for filing an involuntary bankruptcy petition, rendering the question moot.
On March 22, 1999, Vortex submitted a list of its creditors to the Bankruptcy Court under a court order, stipulating that the list could only be released with further court authorization. The appellants did not seek to have the list released but argued that the Bankruptcy Court should have notified all creditors listed regarding a pending involuntary petition, citing Bankruptcy Rule 1003(b). This rule requires a list of creditors when fewer than three creditors file an involuntary petition, allowing additional creditors to join before a hearing if there are twelve or more creditors. However, since more than three creditors initiated the petition, Rule 1003(b) did not apply.
Under 11 U.S.C. 303(h)(1), a court may grant relief on an involuntary petition only if the debtor is generally not paying its debts as they become due, barring any bona fide disputes. The Bankruptcy Court found that Vortex was generally paying its debts, supported by a favorable Dun & Bradstreet credit report and consistent payment of taxes, payroll, rent, utilities, and operating expenses. The question of whether Vortex was paying its debts is treated as a factual determination reviewed for clear error. The appellants argued that a balance sheet analysis would indicate Vortex’s liabilities exceeded its assets, but the court noted that this test is not definitive. Instead, the Ninth Circuit employs a "totality of the circumstances" approach, examining various factors to assess the debtor's payment practices. The court concluded that Vortex had been meeting its obligations, including settling an IRS deficiency, and did not clearly err in its finding that Vortex was generally paying its debts as they came due.
An acrimonious business dispute has emerged, with claims that may not be legitimate for filing an involuntary bankruptcy petition. The three remaining claims do not meet the $10,775 threshold mandated by 11 U.S.C. 303(b)(1) and 104. Since more than three petitioners initiated the involuntary petition, notification to other creditors was not necessary under Bankruptcy Rule 1003(b). The bankruptcy court's finding that Vortex was generally paying its debts as they became due was not clearly erroneous. Although Liberty Tool notified the Court of a global settlement with Vortex on May 8, 2001, this development does not alter the legal analysis as it pertains to the original petition. Only Higgins and his represented creditors remain involved in the dispute, without affecting the previous ruling that disputes over claim amounts are not bona fide if based on counterclaims from unrelated transactions. Appellants argued that the Bankruptcy Court and BAP incorrectly relied on a letter by Scott regarding the connection between the open account and the mold dispute. However, the court found the testimony from Higgins and Scott to be incredible due to their antagonistic history. The letter in question was submitted by Liberty, not Scott, and the Liberty/Vortex dispute does not reflect the bias of Higgins and Scott. The court's consideration of the letter alongside ongoing litigation was appropriate, as credibility pertains to evidence weight rather than admissibility.
