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Involuntary bankruptcy petition upheld: media providers' claims against advertising agency not subject to bona fide dispute.

Trade creditors have the power to involuntarily force a business debtor into bankruptcy. However, the requirements for an involuntary bankruptcy, contained in Section 303 of the Bankruptcy Code, create defenses that a prospective debtor could assert in its fight against the bankruptcy. Creditors considering joining an involuntary petition should tread very carefully; the potential upside might not be worth the risks. Petitioning creditors face the risk of a huge sanctions claim in the event the Bankruptcy Court dismisses their involuntary bankruptcy petition based upon their failure to comply with the requirements of Bankruptcy Code Section 303.

Petitioning creditors seeking relief on an involuntary bankruptcy petition have to prove, among other things, that their claims are not subject to bona fide dispute as to liability or amount. The recent Sixth Circuit Bankruptcy Appellate Panel decision, in In re Marketing and Creative Solutions Inc., addressed whether the claims of the print and broadcast media providers that joined in the filing of an involuntary bankruptcy petition against an advertising agency were subject to bona fide dispute. The media providers' claims were for sums due for advertisements that the agency had placed for its client.

The case raises numerous issues of interest to the broadcast and print media. One issue of particular concern is whether the broadcast and print media providers' claims against the debtor/advertising agency, for the advertising the agency had placed with the media providers on behalf of the agency's client, and that were asserted as part of the involuntary bankruptcy petition filed against the agency, were subject to bona fide dispute and, therefore, justified dismissal of their involuntary petition? The court ruled that the debtor/agency had to prove a legitimate factual or legal basis for disputing the petitioning creditors' claims in order to raise a bona fide dispute that would defeat their involuntary bankruptcy petition. The agency could not satisfy this burden.

As a result, the court upheld the relief granted on the involuntary petition. The petitioning creditors'/media providers' claims for the advertising the agency had placed on behalf of its client were not subject to bona fide dispute, notwithstanding the absence of signed contracts between the agency and the petitioning creditors. The court relied upon an exception to well-settled general agency principles, that would have otherwise excused the agency from liability, because the agency had acted in a manner that showed an intention to make itself liable to the petitioning creditors. This was supported by the course of dealing between the agency and the petitioning creditors and custom and practice in the industry, which the agency did not dispute.

The Facts Of The Case

Marketing and Creative Solutions Inc. (MACS) was an advertising agent for various Spitzer Clothes Stores (Spitzer). MACS created, designed and placed print and television broadcast advertising for Spitzer.

Scripps Howard Broadcasting Co. d/b/a WEWS NewsChannel5 (WEWS); Plain Dealer Publishing Co., d/b/a The Plain Dealer (PDP); and WKYC-TV, Inc. d/b/a, WKYC-TV3 (WKYC) were the owners and operators of print and television broadcasting media in the Cleveland, Ohio market. WEWS and WKYC aired Spitzer television advertisements and PDP carried Spitzer print advertisements that were placed by MACS.

There was no contract between WEWS and MACS. WEWS billed MACS for the television advertisements that MACS had placed for Spitzer. MACS paid all of WEWS's invoices, except the invoices that were part of WEWS's claim asserted in the involuntary bankruptcy petition.

MACS had applied for credit with PDE MACS, through its treasurer, executed PDP's credit application. In the application, MACS acknowledged that PDP would invoice MACS for all Spitzer advertisements that MACS had placed with PDP, and MACS would be responsible for the payment of all of PDP's invoices. At the same time, MACS's president issued a memorandum to PDP that confirmed MACS's obligation to pay for all Spitzer print advertisements placed by MACS with PDP. Thereafter, MACS paid all of PDP's invoices for Spitzer advertisements placed by MACS, except for the invoices that were included in PDP's claim asserted in the involuntary petition.

WKYC and MACS had not entered into any written contract for the running of Spitzer television advertisements with WKYC. WKYC had regularly billed MACS for the Spitzer television advertisements that MACS had placed with WKYC and that WKYC ran. MACS's president had also sent a letter to WKYC acknowledging outstanding indebtedness owing by MACS to WKYC for Spitzer advertisements that MACS had placed with WKYC. MACS also regularly paid all of WKYC's invoices for running such advertisements, except for the invoices that were included in WKYC's claim asserted as part of the involuntary petition.

On July 12, 2004, Spitzer had paid MACS $112,210.98 on two invoices relating to television advertisements that MACS placed with WEWS and WKYC. MACS did not pay WEWS or WKYC for running such advertising.

On October 28, 2004, WEWS, PDP and WKYC filed an involuntary petition for relief under Chapter 7 of the Bankruptcy Code against MACS. The involuntary petition listed WEWS's advertising claim in the amount of $43,284.25 against MACS; PDP's advertising claim in the amount of $113,319.38 against MACS; and WKYC's advertising claim in the amount of $12,962.50 against MACS.

On November 23, 2004, MACS answered the involuntary petition, claiming that the petitioners' claims were subject to bona fide dispute. MACS was disputing liability; there appeared to be no dispute of the amount of the petitioning creditors' claims.

The bankruptcy court granted the involuntary petition, holding that the petitioners' claims were not subject to bona fide dispute. MACS appealed from the bankruptcy court order granting the involuntary petition. That set up the issue for the Sixth Circuit Bankruptcy Appellate Panel.

Grounds For Involuntary Bankruptcy Petition

Section 303 of the Bankruptcy Code contains the requirements for an involuntary bankruptcy petition. Where the debtor has 12 or more creditors, at least three creditors holding unsecured claims of at least $12,300.00 that are not contingent as to liability or the subject of a bona fide dispute as to liability or amount must join in the filing of the involuntary bankruptcy petition. Where the debtor has fewer than 12 otherwise eligible unsecured creditors, excluding any employee or insider and any transferee of a voidable transfer, such as a preference and fraudulent conveyance claim, then one such unsecured creditor, with a claim of at least $12,300, can join in filing an involuntary bankruptcy petition. However, single creditor petitions are very risky and should be the exception, rather than the rule.

The petitioning creditors have the burden of proving that their claims are neither contingent as to liability nor subject to bona fide dispute as to liability or amount. A claim is contingent as to liability where the debtor's obligation to pay the claim is conditioned upon the occurrence of some future event. A goods sold and delivered claim is clearly not contingent. On the other hand, a claim for payment of a sales commission is conditioned upon the occurrence of a sale and is a contingent claim until consummation of the sale.

A claim is subject to bona fide dispute where there are genuine issues of material fact or law that bear on the debtor's liability to the petitioning creditor. A creditor would be disqualified as a petitioning creditor whenever there is any legitimate basis, whether factual or legal, for the debtor's not paying the claim. In determining whether a claim is subject to bona fide dispute, all the court has to consider is whether a dispute exists that warrants the debtor's nonpayment of the claim. The court does not have to determine the probable outcome of the dispute.

If the debtor contests the involuntary petition, the petitioning creditors must also prove that the debtor is generally not paying its debts, not otherwise subject to bona fide dispute as to liability or amount, as such debts become due in order to be granted relief on the involuntary petition. Courts considering whether a debtor is not paying debts as they mature have relied on the number of debts, the amount of delinquency, the materiality of non-payment by the debtor; the total debt compared to the debtor's annual income; the debtor's nonpayment of only the petitioning creditors' claims; and whether the debtor has terminated its business and started liquidating its assets.

The bankruptcy court will grant relief on an involuntary bankruptcy petition where the petitioners have satisfied all of the requirements of Section 303. The court will enter an order for relief on the involuntary petition that will allow the bankruptcy case to proceed.

If the petitioning creditors cannot satisfy all of the requirements necessary to obtain relief on a contested involuntary bankruptcy petition, the bankruptcy court will dismiss the petition. Bankruptcy Code Section 303(i) provides for damage claims that a debtor could assert against the petitioning creditors upon the dismissal of their involuntary bankruptcy petition. The debtor would be entitled to recover its reasonable attorneys' fees and other costs incurred in contesting the petition. And if the court finds that the petitioning creditors had filed the involuntary petition in bad faith, the debtor could recover compensatory damages for its actual losses incurred as a result of the filing of the petition, as well as punitive damages.

The risk that a bankruptcy court could award substantial damage claims against the petitioning creditors is intended to discourage creditors from joining a frivolous bankruptcy petition. The court could award large compensatory and punitive damage claims if the creditors were found to have filed the involuntary petition in bad faith. Such awards are designed to compensate the debtor for the serious harm that could be inflicted by an improperly filed involuntary petition and punish the petitioning creditors for joining in such an improper filing.

The Petitioning Creditors' Claims Were NOT Subject To Bona Fide Dispute

MACS argued that the petitioning creditors' claims were subject to bona fide dispute. MACS claimed that it was acting as Spitzer's agent when it placed Spitzer's advertising with the petitioning creditors, and, therefore, Spitzer--not MACS--was liable to the petitioning creditors. The Sixth Circuit Bankruptcy Appellate Panel (the equivalent of a United States District Court), in the Marketing and Creative Solutions case, considered whether MACS, as Spitzer's agent, could be found primarily liable for the Spitzer advertising that MACS had placed with the petitioning creditors.

The court looked to agency law in making this determination. The court noted that, as a general rule, an agent acting for a disclosed principal, within the scope of his or her authority, is not liable on contracts with the other counterparty. This rule is premised on the fact that the counterparty to the contract had intended to deal with the principal, and not the agent and, therefore, the principal, rather than the agent, should be liable to that counterparty.

However, the court noted two exceptions to this rule that could result in personal liability for the agent. The agent would become personally liable to the contract counterparty based on the agent's actions that show that an intention to make itself liable to the counterparty. Another exception is based on proof that the counterparty had entered into the arrangement based solely and exclusively on the agent's credit.

The court held that the petitioning creditors' claims were not subject to bona fide dispute and upheld the involuntary bankruptcy petition. MACS had demonstrated an intention to make itself liable to the petitioning creditors. MACS's president's issuance of a memorandum to PDP acknowledging MACS's indebtedness to PDP, and MACS's treasurer's execution of PDP's credit application proved that MACS had intended to be primarily liable to PDP. MACS's president's letter to WKYC, acknowledging MACS's indebtedness to WKYC, showed MACS's intention to be primarily liable to WKYC. Finally, WEWS's, WKYC's and PDP's issuance of invoices directly to MACS and MACS's payment of their invoices further demonstrated MACS's intention to be directly liable to them.

The court also noted that other courts had found exceptions that render an agent personally liable for the debts of its principal, based upon custom and usage in the industry and the prior course of dealings between the parties. The court recognized the established custom in the television industry for television stations to hold advertising agencies liable for the purchase of airtime, unless the television station received specific notice of non-liability, even though the television station was aware that the agent was acting for a disclosed principal. WKYC's business manager had testified that the dealings between MACS and WKYC were consistent with the manner in which the broadcast industry typically operates. While WKYC had attempted to get advertising agencies to sign contracts making the agencies expressly liable for the advertisements they had placed with the broadcaster, WKYC was not always successful in obtaining signed contracts. Also both WEWS and WKYC had billed MACS directly, showing an intention to hold MACS liable for the Spitzer advertising placed with them, consistent with industry custom.

Finally, MACS did not dispute the evidence that the petitioning creditors had presented on either the custom and usage in the television industry, or MACS's prior course of dealing with the petitioning creditors. Both supported a finding of MACS's intention to be liable for the petitioning creditors' invoices for Spitzer advertising that MACS had placed with them. Also, MACS did not raise any legal basis for disputing its liability to the petitioning creditors. While the court could not resolve legal issues in connection with a contested involuntary petition, that did not prohibit the court from determining whether there was a legitimate legal dispute. The court found none in holding that the petitioning creditors' claims were not subject to bona fide dispute and affirming relief on their involuntary petition.

Conclusion

Creditors considering joining in the filing of an involuntary bankruptcy petition should carefully consider the risk that the debtor could obtain dismissal of the bankruptcy petition by proving that the petitioners' claims are subject to bona fide dispute. Thankfully for the petitioning creditors/media providers in the Marketing and Creative Solutions case, the Sixth Circuit Bankruptcy Appellate Panel rejected the debtor's/advertising agency's/MACS's argument that the petitioners' claims were subject to bona fide dispute based upon MACS's denial of personal liability for the advertising that MACS had placed with the petitioning creditors on behalf of a known principal, Spitzer. Both the prior course of dealings between MACS and the petitioning creditors and the custom and custom and usage of the industry showed MACS's intention to be personally liable for the advertising MACS had placed, on Spitzer's behalf, with the petitioning creditors. That was more than enough for the court to reject the debtor's argument that the petitioning creditors' claims were subject to bona fide dispute and uphold their involuntary petition.

Bruce S. Nathan, Esq. is a Partner in the law firm of Lowenstein Sandler PC in New York, NY. He is also a member of NACM and is a Co-Chair of the American Bankruptcy Institute Unsecured Trade Creditors Committee. He can be reached via e-mail at bnathan@lowenstein.com.
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Title Annotation:CREDIT COLUMN; Marketing and Creative Solutions Inc
Author:Nathan, Bruce S.
Publication:Business Credit
Geographic Code:1USA
Date:Jun 1, 2006
Words:2500
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