Opinion ID: 782085
Heading Depth: 2
Heading Rank: 3

Heading: Petitioning Creditors' Claims and BDC's Motion to Dismiss

Text: 31 Section 303 requires that a petition for involuntary bankruptcy be brought by at least three qualifying creditors. See 11 U.S.C. § 303(b)(1). Consequently, if the six additional petitioners were correctly dismissed and if the claim of any one of the three original petitioners was correctly held to be subject to a bona fide dispute, we must affirm. Our review of the record convinced us, however, that the claims of all three original petitioners were correctly adjudged to be subject to bona fide disputes.
32 Key claimed that it was owed $231,938 for HVAC work. In seeking dismissal, BDC introduced documentary evidence of a preexisting dispute concerning Key's performance. Specifically, the record contained several letters from BDC to Key, beginning in January 2001, notifying Key that it was in default and demanding performance. The letters also warned Key that if it failed to complete the work, BDC would hire another contractor and backcharge Key for any shortfall or other damages. Key disputed BDC's claim that it was current on its payments and blamed faulty electrical work performed by other contractors for the problems with the HVAC work. BDC ultimately hired another contractor, Dyn-aire, to complete the work under Key's contract. Key claims that even after accounting for any offset for these costs, it is still owed approximately $35,000, but there has been no determination that this amount is, in fact, owed. The Bankruptcy Court found that Key's claim was subject to a bona fide dispute. 33 On appeal, the District Court agreed and rejected Key's contention that at least $35,183 of its claim was undisputed and that, as to that amount, the claim should proceed. The court found that the numbers used to reach the $35,182.66 figure appear to be taken from correspondence between Key and BDC, and do not factor in all potential direct and indirect damages that BDC faced as a result of Key's failure to complete its work. Key I, 2002 WL 449856, at . 34 Key argues that the District Court erred in treating BDC's counterclaims as a defense to the total claim rather than a diminution of the amount. (Br. for Appellant at 18.) BDC responds that [t]he potential contractual damages arising from Key's default ... are not limited to counterclaims, but rather, ... go to the determination as to the existence of Key's claim. (Br. for Appellee at 21.) BDC cites the District Court's finding that Key's numbers do not consider all potential direct and indirect damages caused by Key's breach, suggesting that its costs and damages will exceed any amount Key could recover. 35 While it is clear that a claim is not subject to a bona fide dispute simply because the debtor has an unrelated counterclaim against a petitioning creditor, where a claim for offset arises out of the same transaction and is directly related to the creditor's underlying claim, and, if valid, could serve as a complete defense to that claim, a bona fide dispute exists. See, e.g., Chi. Title Ins. Co. v. Seko Inv., Inc. (In re Seko Inv., Inc.), 156 F.3d 1005, 1008-09 (9th Cir.1998). Here, BDC alleges that Key's default caused undetermined damages likely to exceed any amount Key could recover. Since BDC's claim for offset arises out of the same transaction and relates to Key's claim, and, if valid, would extinguish the claim, the Bankruptcy Court correctly concluded that a bona fide dispute exists.
36 BDC contended that DWF's claim was subject to a bona fide dispute because contractual prerequisites to payment had not been satisfied. BDC relied on section 10.1(f) of the contract between DWF and HRH, which BDC subsequently assumed. That section required that DWF first fully pursue a lien action against the hotel before it could seek to recover directly from BDC: 37 Except to the extent that the Construction Manager [HRH] has received funds for payment to Contractor [DWF], which it has improperly not paid to Contractor, Contractor understands that it shall have claim against Construction Manager for payment on account of the Contract Price for the Project, or any other sums that may be due and payable hereunder, only to the extent that this Contractor has fully pursued its lien rights against the Project for which a claim of non-payment is made under the lien law of the State of New York, including a foreclosure action against same (the  Lien Action ), and then only to the extent that, and for the amount that, Contractor's ultimate recovery from the Owner [BDC], by virtue of the Lien Action, is less than the proper unpaid amount due this Contractor. The Contractor hereby expressly waives any and all claims with respect to any unpaid sums against Construction Manager under this Contract, unless and until the Lien Action is fully completed. 38 (Contract between HRH and DWF, section 10.1(f) (emphases in original).) 39 The Bankruptcy Court, relying on this provision, concluded that DWF's right to payment from BDC had not yet arisen and, therefore, that its claim was subject to a bona fide dispute. The petitioning creditors argued that BDC could not invoke § 10.1(f) because the contract had been drafted with only DWF and HRH in mind. The section, the creditors claimed, was intended to protect the construction manager, HRH, against a claim for payment by DWF in the event BDC failed to pay HRH for work done by DWF. If that occurred, DWF would be required first to proceed directly against the property rather than against HRH. The petitioning creditors claimed that even though BDC assumed the contract, it should not be permitted to wear two hats — that of property owner and that of construction manager — and that it would pervert the very meaning of paragraph 10.1(f) to require DWF to pursue a lien action before pursuing any other action against BDC. (Appellants' Br., Appeal of Order of the Bankruptcy Court dated July 2, 2001, at 18.) The District Court rejected this contention: Appellants cite no authority for the proposition that a party who assumes the rights and obligations under a contract can be barred from enjoying some of those rights because of the original intention of the drafters without any direct contractual language to that effect. Key I, 2002 WL 449856, at . 40 We agree with the District Court. When BDC assumed the DWF-HRH contract, it succeeded to HRH's rights under the contract and was entitled to require DWF to pursue a lien action against the hotel before seeking payment directly from BDC. That BDC is both the construction manager under the contract and the property owner does not change this result. See, e.g., Tanbro Fabrics Corp. v. Deering Milliken, Inc., 35 A.D.2d 469, 471, 318 N.Y.S.2d 764, 767, aff'd 29 N.Y.2d 690, 325 N.Y.S.2d 419, 274 N.E.2d 751 (1971). Since DWF failed fully to pursue a lien action, its right to payment had not matured and, as the District Court correctly found, its claim was subject to a bona fide dispute.
41 Mesta was a tiling subcontractor of Tveter. Contending that it was never fully paid by Tveter, Mesta sought, through a mechanic's lien, to collect the contract balance from BDC. A mechanic's lien permits a subcontractor to assert a lien against the property, regardless of whether privity with the owner exists. See N.Y. Lien Law § 3; Rure Assocs., Inc. v. DiNardi Constr. Corp., 917 F.2d 1332, 1335-36 (2d Cir.1990). A subcontractor, however, may only assert a lien to the extent that there are funds due and owing to the general contractor by the property owner under the principal contract. See N.Y. Lien Law § 4(1) (lien extends only to amount earned and unpaid on general contract at the time of the filing of the lien); Rure Assocs., 917 F.2d at 1335-36. The evidence before the Bankruptcy Court indicated that BDC had made some payments to Tveter, but that BDC may still have owed Tveter $9,846, which would have permitted Mesta to proceed as a lienor against BDC. 42 The Bankruptcy Court found that Mesta lacked standing against BDC, and, alternatively, that Mesta's claim was subject to a bona fide dispute. The District Court, however, found that the conflicting evidence as to whether BDC owed additional amounts to Tveter raised a genuine issue of material fact as to whether Mesta had standing as a lienor, and that it was therefore improper for the Bankruptcy Court to have found that Mesta lacked standing. But because we conclude that there is an objective basis for a factual dispute as to whether BDC paid Tveter in full — and thus, a question as to whether Mesta can properly proceed against BDC as a lienor — Mesta's claim is subject to a bona fide dispute, as the Bankruptcy Court correctly concluded.
43 The six additional creditors who sought to join the petition held secured claims in the form of mechanic's liens against the hotel. The Bankruptcy Court concluded that the six were ineligible to join as petitioning creditors under 11 U.S.C. § 303(c) because none held unsecured claims. Section 303(c) provides: 44 After the filing of a petition under this section but before the case is dismissed or relief is ordered, a creditor holding an unsecured claim that is not contingent, other than a creditor filing under subsection (b) of this section, may join in the petition with the same effect as if such joining creditor were a petitioning creditor under subsection (b) of this section. 45 The statute plainly requires that joining creditors hold unsecured claims. As the District Court noted, while several of these creditors may have indicated a willingness to waive some or all of their security should Key or Mesta be found to be ineligible as petitioning creditors, none had actually done so by the time the Bankruptcy Court resolved BDC's motion, and § 303(c) requires that petitioning creditors join before the case is dismissed or relief is ordered. 11 U.S.C. 303(c). Accordingly, we conclude that the Bankruptcy Court correctly held that these additional creditors were ineligible, and it properly dismissed the petition.