Boston Beverage Corp. v. TurnerBoston Beverage Corp. v. Turner
MEMORANDUM AND DECISION ON PETITIONING CREDITORS’ APPEAL FROM THE ORDER OF THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF MASSACHUSETTS DISMISSING THE INVOLUNTARY BANKRUPTCY PETITION
This case arises from the bankruptcy of three liquor stores owned by appellee John C. Turner (“Turner”). Turner was the sole stockholder and manager of the three stores, Thrifty Liquors, Inc., Turner’s Package Store, Inc., and Medford Thrifty Liquors, Inc. (“Corporate Debtors”). Appellants Boston Beverage Corp., M.S. Walker, Inc., August Busch & Co. of Massachusetts, Inc., Whitehall Co., Ltd., and Crown Distributors, Inc. (“Petitioning Creditors”), are liquor wholesalers who sold goods to the Corporate Debtors.
On May 21, 1982, the Corporate Debtors commenced voluntary bankruptcy proceedings pursuant to Chapter 11 of the Bankruptcy Code (the “Code”). Petitioning Creditors held claims against the Corporate Debtors. Three days later, on May 24, 1982, the Petitioning Creditors brought an involuntary bankruptcy petition against Turner himself under Chapter 7 of the Code. The Petitioning Creditors alleged that Turner was personally responsible for the debts of the Corporate Debtors, that he had failed to pay these and other debts, and that he was generally not paying his debts when due. Turner denied the Petitioning Creditors’ allegations and counterclaimed, asserting that the involuntary petition had been filed in bad faith and in retaliation for the voluntary filing of the Corporate Debtors.
At the same time, Turner moved for summary judgment on Petitioning Creditors’ claims. He argued that because the claims were contingent as to liability, Petitioning Creditors lacked standing to bring the petition against him.
See
11 U.S.C. § 303(b)(1). The bankruptcy judge granted summary judgment as to five of Petitioning Creditors’ six claims,
In re Turner,
At the second trial, the Petitioning Creditors sought to show that as of May 24, 1982, the date the petition was filed, Turner was generally not paying his debts when due. They sought to show that he had failed to pay: (i) the twelve dishonored checks, totalling some $35,000, which were the subject of the first trial; (ii) four dishonored checks in the sum of $7,136.50 written to Martignetti Grocery Company (“Martignetti”) on accounts maintained by the Corporate Debtors but signed by Turner without reference to his representative capacity; (iii) one dishonored check for $7,034.90 written to Charles Gilman
&
Sons, Inc. (“Gilman”) on accounts maintained by the Corporate Debtors but signed by Turner without reference to his representative capacity; (iv) rent of $2,000 due under a written guarantee executed by Turner guaranteeing the rental payments of one of the Corporate Debtors (the “rent guarantee”); (v) claims in excess of $200,-
The bankruptcy judge ruled that for purposes of the Code the only personal debt Turner was not paying at the time the petition was filed was the Ahearn judgment for $4,864.50. He found the other alleged unpaid debts to be either disputed, not due or not Turner’s personal obligation. The judge further ruled that in the six months before the petition was filed, Turner had paid personal consumer and home mortgage debt totalling $15,760.28. Weighing the unpaid Ahearn judgment against the paid debt, the bankruptcy judge concluded that he could not find that Turner was generally not paying his debts when due. Consequently, he dismissed the involuntary petition.
Petitioning Creditors appeal numerous aspects of the bankruptcy judge’s ruling that Turner was generally paying his debts when due. They also challenge the judge’s ruling on Turner’s motion for summary judgment that five of their six claims were contingent. Turner’s counterclaim against Petitioning Creditors has been stayed pending the outcome of this appeal.
I. Was Turner Generally Not Paying His Debts When Due?
The Code provides that a “court shall order relief against the debtor in an involuntary case ... only if (1) the debtor is generally not paying such debtor’s debts as such debts become due_” 11 U.S.C. § 303(h)(1). There is no mechanical rule for determining when a debtor is generally not paying his or her debts when due.
See In re B.D. International Discount Corp.,
The “Generally Not Paying” Category
The bankruptcy judge excluded from his determination all of Turner’s debts subject
Petitioning Creditors argue that the bankruptcy judge erred as a matter of law in excluding disputed debts from his calculations. The judge relied upon 11 U.S.C. § 303(h)(1), which states that a court may order relief pursuant to an involuntary petition “only if ... the debtor is not paying such debtor’s debts as such debts become due unless such debts are the subject of bona fide dispute_” 11 U.S.C. § 303(h)(1) (emphasis, supplied). Congress added the underlined language in 1984, two years after Petitioning Creditors filed their petition, see Bankruptcy Amendments and Federal Judgeship Act of1984, Pub.L. No. 98-353, § 426(b) (the “1984 Amendments” or “Act”), and Petitioning Creditors contend that application of the amendment to a pending petition was contrary to the intent of Congress and manifestly unjust. I rule that both the language of the statute and its legislative history indicate that Congress intended that section 426(b) apply to all cases, including this case, pending on the date the Act was adopted, and I find no manifest injustice in such an application.
Congress passed the 1984 Amendments on July 10, 1984. Section 553 of the Act made most of the substantive provisions of the Act applicable to “cases filed 90 days after the date of enactment.” Pub.L. No. 98-353, § 553(a). The next paragraph, however, carved out an exception for section 426(b) of the Act. That section was to “become effective upon the date of enactment” of the Act. I find it significant that Congress expressly made most of the Act applicable to “cases filed” after a certain date, while allowing section 426(b) simply to “become effective.” Had Congress intended that section 426(b) not apply to pending cases, it would most likely have provided for the section to become effective for cases filed after the date of enactment. Its failure to use this language, which it had used in the previous sentence, suggests that Congress intended that section 426(b) be applied immediately upon enactment to both pending and subsequently filed cases.
The legislative history strongly supports the conclusion that Congress intended that section 426(b) apply to pending cases. Congress adopted section 426(b) to correct the misinterpretation of the law made by a few of the courts applying chapter 7 of the Code. The sponsor of section 426(b) stated at the time of its passage:
The problem can be explained simply. Some courts have interpreted section 303’s language on a debtor’s general failure to pay debts as allowing the filing of involuntary petitions and the granting of involuntary relief even when the debtor’s reason for not paying is a legitimate and good-faith dispute over his or her liability. This interpretation allows creditors to use the Bankruptcy Code as a club against debtors who have bona fide questions about their liability, but who would rather pay up than suffer the stigma of involuntary bankruptcy proceedings.
My amendment would correct this problem. Under my amendment, the original filing of an involuntary petition could not be based on debts that are the subject of a good-faith dispute between the debtor and his or her creditors. In the same vein, the granting of an order of relief could not be premised solely on the failure of a debtor to pay debts that were legitimately contested as to liability or amount.
I believe this amendment, although a simple one, is necessary to protect the rights of debtors and to prevent misuse of the bankruptcy system as a tool of coercion. I also believe it corrects a judicial misinterpretation of existing law and congressional intent as to the proper basis for granting involuntary relief
130 Cong.Rec. S7618. (June 19, 1984) (Comments of Senator Baucus) (emphasis added) (hereinafter cited as “Comments of Senator Baucus”).
Where Congress intends that a law apply to pending cases, it should be so applied unless it will cause the parties “manifest injustice.”
Bradley v. School Board of the City of Richmond,
The only other court to consider whether section 426(b) applied to pending cases reached the same conclusion and applied section 426(b) to a case pending on July 10, 1984.
See In re Stroop,
In addition to challenging the bankruptcy judge’s holding that disputed debts must be excluded from the generally not paying category, Petitioning Creditors also challenge his factual finding that certain debts were subject to bona fide dispute. I may overturn the bankruptcy judge’s factual findings only if they are clearly erroneous.
See
Bankruptcy Rule 8013;
In re Dill,
I find no error in the bankruptcy judge’s conclusion that at the time the bankruptcy petition was filed, the twelve checks held by Petitioning Creditors, the checks held by Martignetti and Gilman, and the four state court cases were debts subject to bona fide dispute. On May 24,1982, it was by no means clear that Turner would be found personally liable on the twelve checks held by Petitioning Creditors. The checks were drawn on corporate accounts in payment for goods delivered to the Corporate Debtors. Each check bore on its face the name and address of one of the Corporate Debtors. The bankruptcy judge found that in the months between the return of the cheeks and the corporate bankruptcy filings, the Petitioning Creditors considered these to be corporate debts and looked to the corporations rather than Turner for payment. The bankruptcy judge decided that Turner was personally liable for the checks only in August, 1983, more than a year after the petition was filed. His decision rested on a technical point in the law of commercial paper, that an authorized representative who signs a check without indicating his representative capacity may be personally liable on the check, and the judge recognized that the decisions on the point were in conflict.
Turner,
Petitioning Creditors argue that the bankruptcy judge determined in his 1983 decision that the checks held by them were not subject to dispute and that the bankruptcy judge was required to adhere to this ruling in the second trial. But Petitioning Creditors mischaracterize the judge’s decision. The judge established not that there was no dispute as to the checks, but merely that Turner was liable on them.
See id.
A debt may be subject to good faith dispute even where the debtor eventually loses the dispute on the merits.
See In re Lough,
Similarly, a bona fide dispute existed regarding Turner’s individual liability for the Martignetti and Gilman checks. These checks were also drawn on the Corporate Debtors’ accounts in payment of the Corporate Debtors’ obligations. Turner’s personal liability for those checks rests on the same technical grounds as his liability for the twelve checks held by Petitioning Creditors. Turner was not individually liable on these checks absent a judicial determination of liability, and on May 24, 1982, the outcome of any such determination was subject to bona fide dispute. On the date the petition was filed, therefore, a bona fide dispute existed as to Turner’s liability on the Martignetti and Gilman checks.
The bankruptcy judge also concluded that the claims raised in the four state court cases against Turner, if not inadmissible as hearsay evidence, would be debts subject to a bona fide dispute. This conclusion is supported by the evidence: in each of the four cases Turner raised a colorable claim.
William T. Greene v. James F Turner and John C. Turner,
Middlesex Superior Court No. 81-1761, involved claims by each party against the other. Greene was the payor on a promissory note made in connection with his purchase of a liquor store from Turner. Greene continued to make payments on the note during the pendency of the litigation and the case settled only after May 24, 1982. There is no evidence to suggest that this was not a bona fide dispute. In
Richard K. Foley v. Thrifty Liquor Stores, Inc., et al.,
Middle-sex Superior Court No. 81-3710, Turner asserted that he was entitled to retain a deposit Foley had given him when Foley refused to complete the purchase of a liquor store. In
Daniel T. Hayes, et al,
The Petitioning Creditors attack Turner’s credibility as a witness and argue that the bankruptcy judge erred in believing Turner’s testimony that the dishonored checks and state court cases concerned debts subject to bona fide dispute. Turner testified that there was a genuine dispute regarding his liability on the various corporate checks and the claims raised in the state court litigation. Petitioning Creditors point to inconsistencies in other parts of Turner’s testimony, as well as his alleged reputation for untruthfulness, as reasons why the bankruptcy judge erred in believing Turner’s testimony that the debts were subject to bona fide dispute. I do not find the bankruptcy judge’s acceptance of Turner’s testimony to be clearly erroneous. The Petitioning Creditors do not appear to have adduced any evidence to contradict Turner’s testimony on this point, and the issues raised as to each debt are objectively colorable. Moreover, it would be improper for me to overturn the bankruptcy judge’s assessment of Turner’s credibility as a witness. The judge observed Turner’s testimony and is in a better position to assess his credibility than am I. The mere fact that the bankruptcy judge chose to discount Turner’s testimony as to the Ahearn judgment does not require that he disbelieve other testimony supported by external facts or common sense. I find no error in the bankruptcy judge’s conclusion that the twelve checks written to Petitioning Creditors, the Martignetti and Gilman checks and the four state court suits were disputed debts.
The bankruptcy judge also refused to find that Turner was not paying debt under the rent guarantee and guarantees of corporate debt held by Bay-Bank/Harvard Trust and Malden Trust Company. The judge found that Turner was personally obligated to pay rent due on Medford Thrifty Liquors, Inc.’s lease, but he refused to find that payment on that debt was overdue. The rent was due for the month of May, and thus did not become Turner’s personal obligation until May 21, 1982, when the Corporate Debtors filed the voluntary petition. The debt had been due for only three days when the involuntary petition was filed against Turner, and the landlord did not make demand for payment upon Turner in the three days between May 21 and May 24. Mere failure to demand payment of a debt does not necessarily excuse failure to pay the debt.
See In re All Media Properties,
Turner had also guaranteed some $55,000 in corporate obligations payable to BayBank/Harvard Trust and Malden Trust Company. All corporate payments on these obligations were current in May, 1982, and the guarantees were triggered only by the filing of the Corporate Debtors’ voluntary petition. As with the rent guarantee, Turner had only three days in which to make payment on the guarantees before the involuntary petition was filed, and Turner received no demand for payment from the banks. I find no error in the bankruptcy judge’s conclusion that these debts, like the rent guarantee, while technically an obligation personal to Turner, were
Petitioning Creditors object to several evidentiary rulings made by the bankruptcy judge. At trial the Petitioning Creditors attempted to introduce into evidence pleadings from the four state court cases discussed previously. The bankruptcy judge refused to accept the pleadings into evidence, but accepted docket sheets from the cases for the limited purpose of proving that the claims existed. Petitioning Creditors argue that the judge’s refusal to admit the pleadings was error because they sought to introduce the pleadings merely to show the existence of the claims and Turner’s treatment of them. The docket sheets were, however, adequate evidence that the claims existed. Turner admitted this and the judge took it as fact. The pleadings would not show how Turner treated the claims. If introduced to demonstrate the truth of the allegations contained therein, the pleadings would clearly have been hearsay. See Fed.R.Evid. 801. The pleadings excluded by the bankruptcy judge were irrelevant to any use permitted by the hearsay rules.
Petitioning Creditors challenge the bankruptcy judge’s exclusion of evidence as to Turner’s alleged liability for taxes owed by the Corporate Debtors and other corporations. Petitioning Creditors sought to present evidence that Turner was responsible for the collection of the state and federal taxes of the Corporate Debtors, plus several other corporations, and that these corporations owed substantial amounts of overdue taxes at the time the petition was filed. The judge excluded this evidence.
Under both federal and state law, the corporate officer responsible for the collection and payment of tax liability may be personally liable for any amounts wrongfully withheld by the corporation. I.R.C. § 6672; M.G.L. c. 62B, § 5. To the extent he was responsible for the collection and payment of state and federal tax liabilities of the Corporate Debtors or other corporations, Turner therefore may be personally liable for amounts wrongfully withheld by those corporations. However, at the time the involuntary petition was filed, Turner was not presently liable, for any such amounts. Under the Internal Revenue Code, Turner could be required to pay the corporate tax liabilities only upon “notice and demand” by the government. I.R.C. § 6671(a). And under Massachusetts law, Turner’s personal liability could accrue only thirty days after notice from the Commonwealth. M.G.L. c. 62C, § 31A. Neither the federal government nor the Commonwealth had provided Turner with notice óf his personal liability for the overdue corporate taxes as of May 24, 1982. Nor had they demanded payment of the corporate taxes. And as of May 24, no court had adjudged Turner liable for those debts. The tax liabilities of the Corporate Debtors or other corporations, while potentially Turner’s personal liability, were therefore not debts due as of May 24, 1982. Evidence as to the corporate tax debts was properly excluded as irrelevant by the bankruptcy judge.
The Petitioning Creditors also challenge the bankruptcy judge’s exclusion of evidence allegedly showing that Turner wrongfully took money from the Corporate Debtors. This evidence was not relevant to the issue of whether, as of May 24, 1982, Turner was generally paying his debts when due. Evidence bearing on Turner’s conduct of his own financial affairs clearly would have been relevant to determining whether Turner was generally paying his debts when due.
See In re the Leek Corporation, 52
B.R. at 314;
In re Reed,
The Generally Paying Category
In addition to challenging the bankruptcy judge’s exclusion of numerous alleged debts from the generally not paying category, the Petitioning Creditors challenge the inclusion of Turner’s consum
Nor did the bankruptcy judge err in including Turner’s home mortgage debts in the generally paying category. Petitioning Creditors suggest that because the Code provides no affirmative relief to fully secured creditors and because a fully secured debt cannot ground a creditor’s standing to bring an involuntary bankruptcy petition, the bankruptcy judge should not have considered Turner’s regular mortgage payments in determining whether he was generally paying his debts when due. The Code provides no relief or standing for fully secured creditors because state collection and foreclosure proceedings allow them tó protect their interests adequately. This concern is not at all relevant when deciding whether a debtor is paying his debts. In fact, that Turner was making substantial monthly mortgage payments is very relevant to determining whether he is generally paying his debts and whether it is appropriate to adjudge him an involuntary bankrupt. The courts have held that failure to pay secured debt is evidence of failure to pay one’s debts generally, just as is failure to pay unsecured debt.
Hill v. Cargill, Inc.,
Nor did the bankruptcy judge err in considering debts paid by Turner during the previous six months in making his determination. There is a conceptual difficulty in determining what debts a debtor was paying as of a certain date. The bankruptcy judge could not look only at debt payments Turner made on May 24, 1982. To get an accurate picture of Turner’s financial condition, he had to look at the pattern of payments made by Turner before the petition was filed. I cannot say that he erred in choosing six months as a reasonable period for discerning such a pattern. Six months is enough time for a pattern of payment or nonpayment to emerge, but it is not so long as to distort the picture of Turner’s current financial situation.
Petitioning Creditors further contend that the bankruptcy judge erred in refusing to consider “other factors” in his decision, specifically, the sources of Turner’s payments, Turner’s future inability to pay his debts and Turner’s “overall” handling of his financial affairs. These arguments merely restate Petitioning Creditors’ allegations regarding Turner’s mishandling of the Corporate Debtors’ affairs. As the bankruptcy judge made clear, this was an action for bankruptcy against Turner personally. Evidence as to the debts of the Corporate Debtors and Turner’s handling
After reviewing the evidence, I find that the bankruptcy judge was correct in finding only three debts relevant to his inquiry: the Ahearn judgment for $4,864.50, which Turner had not paid; the consumer debt, on which Turner had made payments during the six months before May 24, 1982 totalling $8,185.28; and the mortgage payments, which Turner had made regularly. Balancing these debts, the bankruptcy judge found that, all things considered, Turner was generally paying his debts when due.
Contrary to Petitioning Creditors’ assertions, the bankruptcy judge did not simply compare the amount paid by Turner over six months against the Ahearn judgment. He explicitly relied upon the test set forth in
All Media Properties,
generally not paying debts includes regularly missing a significant number of payments to creditors or regularly missing payments which are significant in amount in relation to the size of the debtor’s operation.
I find no error in his conclusion that under this approach, Turner was generally paying his debts when due. Turner’s failure to pay a single debt, even for a long period, does not necessarily suggest insolvency. In fact, a debtor’s failure to pay one debt will not usually justify finding that the debtor is generally not paying his or her debts.
See In re Reed,
II. The Summary Judgment Decision
Petitioning Creditors had standing to assert only those claims which were “not contingent as to liability” on the date the petition was filed. 11 U.S.C. § 303(b)(1). Turner moved for summary judgment against the Petitioning Creditors on the grounds that their claims were contingent, and hence they had no standing to file an involuntary petition against him. Petitioning Creditors asserted six claims that they argued were not contingent. They claimed that: (i) Turner was liable for issuing checks to Petitioning Creditors without knowing whether there were sufficient funds in corporate accounts to cover the checks; (ii) Turner had agreed to cause Corporate Debtors to repay outstanding indebtedness (“Contract Claims”); (iii) Turner fraudulently misrepresented the Corporate Debtors’ ability to pay Petitioning Creditors (“Tort Claim”); (iv) Turner illegally operated the Corporate Debtors, thereby rendering himself personally liable for debts incurred; (v) Turner operated the Corporate Debtors in disregard of corporate formalities (“Alter Ego Claims”); and (vi) Turner was personally liable on checks drawn on corporate accounts but signed by him without any indication of his representative capacity. The bankruptcy judge ruled that the Contract Claims, Tort Claim and Alter Ego Claims (claims ii-v) were all contingent as to liability.
In re Turner,
An involuntary case is commenced by the filing with the bankruptcy court of a petition under chapter 7 or 11 of the title—
(1) by three or more entities, each of which is ... a holder of a claim against such person that is not contingent as to liability....
11 U.S.C. § 303(b). The Code did not define the term contingent, and the courts before 1984 were divided in their interpretation of the term.
In re Reid,
Allowing parties to file an involuntary petition based upon unlitigated claims would permit plaintiffs to use bankruptcy as a club to force potential defendants to settle their claims. See Comments of Senator Baucus. Allegations of bankruptcy can disrupt even stable businesses, and the threat of filing an involuntary petition could prove a powerful weapon for plaintiffs. Moreover, disputed claims should not be resolved in bankruptcy court where, as is the case here, there are adequate state court remedies. The bankruptcy judge’s holding that claims not yet litigated are contingent embodies the better rule. This interpretation serves the purposes of the Bankruptcy Code by ensuring that disputed common law claims are resolved in nonbankruptcy courts and by preventing the use of the Code to coerce parties with disputed claims to give up on their disputes or settle their cases. I find no error in the judge’s ruling that Petitioning Creditors' Tort, Contract and Alter Ego Claims were contingent and hence no basis for standing.
Conclusion
Accordingly, the decision of the Bankruptcy Court dismissing the involuntary petition is AFFIRMED.
Notes
. Petitioning Creditors also argue that the bankruptcy judge overstated the amount of mortgage payments actually made by Turner in the months preceding filing of the petition. I do not find it necessary to decide this issue because even accepting Petitioning Creditors’ figures, I find that the bankruptcy judge was correct in his conclusion that Turner was generally paying his debts when due.