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Second Time May Be the Charm for the Eleventh Circuit on Subject Matter Jurisdiction in Involuntary Bankruptcy Cases

Courts often wrestle with navigating the subtle distinctions between “subject matter” jurisdiction over a controversy, on the one hand, and the essential ingredients of a claim for relief, on the other. Along those lines, in In re Trusted Net Media Holdings, LLC (“Trusted Net II”), the U.S. Court of Appeals for the Eleventh Circuit, sitting en banc, recently held that the requirements for commencing an involuntary bankruptcy case in section 303(b) of the Bankruptcy Code are not subject matter jurisdictional in nature and thus may be waived. The decision reversed a prior panel decision of the Circuit (“Trusted Net I”) holding that, contrary to the majority of the courts that have addressed the issue, section 303(b) is subject matter jurisdictional. The reversal does not come as a surprise, however, because the Trusted Net I panel had held that although the majority reasoning on the issue was more persuasive, it was bound by prior Eleventh Circuit precedent that appeared to hold that section 303(b)’s requirements were indeed subject matter jurisdictional. Presumably in light of the reluctance of the Trusted Net I panel’s ruling, among other reasons, the Eleventh Circuit vacated the Trusted Net I decision and reheard the case en banc. Ultimately, the Trusted Net II decision relied on U.S. Supreme Court and other precedent in holding that section 303(b) is not subject matter jurisdictional and that to the extent that prior Eleventh Circuit precedent held otherwise, it was overruled.

Jurisdiction Over Involuntary Bankruptcy Cases

Congress established the jurisdiction of the bankruptcy courts in title 28 of the United States Code. Title 28 provides generally that the district courts shall have “original and exclusive jurisdiction of all cases under title 11” and “original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11.” Title 28 further provides that each bankruptcy court is “a unit of the district court” in the federal district where it is located. Finally, title 28’s jurisdictional strictures for bankruptcy courts provide that “[b]ankruptcy judges may hear and determine all cases under title 11 and all core proceedings arising under title 11, or arising in a case under title 11 . . . .”

Although most bankruptcy cases are initiated voluntarily by the debtor, creditors may force the debtor into bankruptcy involuntarily. Section 303(b) of the Bankruptcy Code contains the requirements for commencement by creditors of an involuntary chapter 7 or 11 bankruptcy case against a debtor. It provides, in pertinent part, that the case must be filed:

(1) by three or more entities, each of which is either a holder of a claim against such person that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount, or an indenture trustee representing such a holder, if such noncontingent, undisputed claims aggregate at least $13,475 more than the value of any lien on property of the debtor securing such claims held by the holders of such claims; [or]

(2) if there are fewer than 12 such holders, excluding any employee or insider of such person and any transferee of a [voidable transfer ] . . . , by one or more of such holders that hold in the aggregate at least $13,475 of such claims.

At issue in Trusted Net was whether these requirements are jurisdictional, such that the bankruptcy court, notwithstanding the jurisdictional grant in title 28, may assert subject matter jurisdiction over an involuntary case only if section 303(b)’s requirements have been satisfied.

Trusted Net

Trusted Net Media Holdings, LLC (“Trusted Net”), was an internet service provider based in Marietta, Georgia. In 2002, one of Trusted Net’s creditors filed an involuntary chapter 7 petition against the company, claiming that it held a trade debt or judgment in the amount of “not less than $534,000.” An order for relief was entered into the case after Trusted Net failed to contest the petition. Two years afterward, Trusted Net filed a motion to dismiss the case, arguing that: (i) the petitioning creditor’s claim against the debtor was subject to bona fide dispute, and thus, such creditor did not hold a noncontingent, undisputed claim against the debtor; and (ii) Trusted Net had more than 12 eligible creditors, so that an involuntary filing by a single creditor was invalid. The bankruptcy court denied the motion to dismiss and no appeal was taken.

Two more years later, after five of Trusted Net’s creditors had settled their claims with the chapter 7 trustee, Trusted Net again filed a motion to dismiss the case based on lack of subject matter jurisdiction. This time, the debtor reiterated its previous arguments in support of dismissal but further maintained that section 303(b)’s requirements must be met in order for the bankruptcy court to have subject matter jurisdiction. The bankruptcy court again denied the motion, reasoning that section 303(b) was not jurisdictional and any argument by the debtor that the petitioning creditor’s claim was subject to a bona fide dispute or that other creditors needed to join the petition was waived because the debtor failed to raise it earlier in the case. The district court upheld that determination on appeal without elaboration, finding that the bankruptcy court’s ruling was well reasoned and correct. Trusted Net appealed to the Eleventh Circuit, confining the scope of its appeal, however, to that aspect of the ruling pertaining to the allegedly jurisdictional requirements of section 303(b), which Trusted Net maintained cannot be waived.

The Eleventh Circuit’s Initial Ruling

The precise issue considered by the court of appeals was whether, notwithstanding the clear grant of jurisdiction over bankruptcy cases to bankruptcy courts in title 28, section 303(b) of the Bankruptcy Code must be satisfied in order to confer subject matter jurisdiction upon the bankruptcy court over involuntary bankruptcy cases or “whether, instead, they are merely substantive matters which must be proved or waived for petitioning creditors to prevail in involuntary proceedings.” Acknowledging the existence of a split in the Circuits on this issue, the Eleventh Circuit examined the rationale underlying both sides.

The Ninth Circuit, as articulated in its 1985 ruling in In re Rubin, along with the majority of the courts that examined the issue, held that petitioning creditors in an involuntary case cannot prevail unless they can prove that their claims are not subject to bona fide dispute, but that the bankruptcy courts are not without subject matter jurisdiction prior to making this determination. According to this view, because title 28 vests the bankruptcy court with jurisdiction over all cases under title 11, the requirements of section 303(b) may be waived. By contrast, the minority approach, exemplified by the Second Circuit’s 2003 ruling in In re BDC 56 LLC, is that the requirements of section 303(b) are jurisdictional. In BDC, the court of appeals reasoned that the bankruptcy court must determine whether section 303(b)’s requirements have been met at the earliest possible juncture to prevent creditors with disputed claims from inappropriately hauling a solvent debtor into bankruptcy court and forcing it to defend an involuntary petition while the bankruptcy court leaves for a later determination the propriety of the petition.

In Trusted Net I, the Eleventh Circuit panel found the majority approach to be the more logical and persuasive for two important reasons. First, it noted that such decisions comport with the basic nature of subject matter jurisdiction—the ability to hear a class of cases—because, as a class of cases, involuntary bankruptcy cases unquestionably arise under title 11 and thus fall within the grant of jurisdiction to bankruptcy courts under title 28. Second, the panel explained, the decisions are more consistent with section 303’s language: (i) section 303(b) makes no reference to jurisdiction; (ii) section 303(h) of the Bankruptcy Code provides that “[i]f the petition is not timely controverted, the court shall order relief against the debtor”; and (iii) section 303(c) states that a creditor that has not joined the involuntary petition may be added before the case is dismissed or relief ordered. According to the court, it would be anomalous to permit the court, in a case where it lacks subject matter jurisdiction due to noncompliance with the requirements of section 303(b), to manufacture such jurisdiction merely by adding more eligible petitioning creditors to the case.

Ultimately, however, the Eleventh Circuit panel held in Trusted Net I that although the great weight of authority and, in its opinion, superior reasoning supported a holding that the requirements of section 303(b) are not jurisdictional and can be waived, it was bound by prior precedent to rule otherwise. In In re All Media Properties, the Court of Appeals for the Fifth Circuit (from which the Eleventh Circuit was created in 1980) affirmed a bankruptcy court ruling regarding a challenge to an involuntary case under section 303(b). In that case, the bankruptcy court held that the petitioning creditors’ claims were not contingent and therefore satisfied section 303(b). Although the procedural posture of the case differed from that of Trusted Net I—the All Media debtors challenged the petition immediately so that there was no waiver issue—the opinion was replete with references to section 303(b)’s requirements as “jurisdictional” and, according to the Eleventh Circuit panel in Trusted Net I, of the “non-waivable, subject matter jurisdiction variety.” Due to the express holding of All Media, the Trusted Net I panel considered itself bound to follow the ruling.

The Eleventh Circuit’s Ruling on Rehearing

The Eleventh Circuit vacated its ruling in Trusted Net I less than two months afterward and agreed to rehear the matter en banc on October 20, 2008. On rehearing en banc, the Trusted Net II court joined the majority, holding that section 303(b)’s requirements are not subject matter jurisdictional in nature and thus may be waived. In order to get there, the court first recognized that it had to clarify “two sometimes confused or conflated concepts: federal-court ‘subject matter’ jurisdiction over a controversy; and the essential ingredients of a federal claim for relief.” With respect to subject matter jurisdiction, the court noted that a federal court has an independent obligation to determine whether it has subject matter jurisdiction over a controversy even if no party raises the issue. If the court finds that it does not, it must dismiss the case. On the other hand, if a cause of action fails, that does not automatically produce a failure of jurisdiction.

For instruction on this murky issue, the court turned to the U.S. Supreme Court’s 2006 decision in Arbaugh v. Y & H Corp., where the court ruled that title VII’s requirement that an “employer” have “fifteen or more employees” is not subject matter jurisdictional, but instead relates only to the “substantive adequacy” of a title VII plaintiff’s claim and thus cannot be raised for the first time post-trial. Adopting some of the Supreme Court’s reasoning in that case, the Eleventh Circuit held that section 303(b) of the Bankruptcy Code: (i) does not evince a congressional intent to implicate the bankruptcy court’s subject matter jurisdiction; (ii) contains no explicit reference to its requirements being jurisdictional and never uses the word “jurisdiction”; and (iii) merely states that an involuntary bankruptcy case is commenced by filing a petition that meets certain requirements.

The Eleventh Circuit explained that it had previously interpreted similar “commencement of the case” language, found elsewhere in the Bankruptcy Code, as nonjurisdictional. In particular, the court had previously ruled that sections 546(a) and 549(d) of the Bankruptcy Code, which establish limitations periods on a trustee’s avoiding powers and, like section 303(b), provide conditions under which a proceeding under title 11 may be “commenced,” were waivable statutes of limitations, rather than restrictions on a bankruptcy court’s subject matter jurisdiction. Among other reasons, the court had relied upon the fact that the subject matter jurisdiction of bankruptcy courts derives from title 28 and that neither section 546(a) nor section 549(d) explicitly refers to jurisdiction. According to the Eleventh Circuit, the conclusion that section 303(b) is nonjurisdictional comports with the bankruptcy-related jurisdictional grant in title 28, as well as the basic nature of subject matter jurisdiction: the statutorily conferred power of the court to hear a class of cases (e.g., involuntary bankruptcy cases).

Like the majority of courts that have addressed the issue, the Eleventh Circuit stated that its holding was consistent with the language of section 303, for the same reasons the Eleventh Circuit panel previously articulated in Trusted Net I but felt bound to disregard due to binding precedent to the contrary. The Eleventh Circuit found Trusted Net’s reliance on the Supreme Court’s 1923 ruling in Canute Steamship Co. v. Pittsburgh & West Virginia Coal Co. to be misplaced. In considering a similar issue arising under the former Bankruptcy Act of 1898, the Supreme Court noted that “the filing of [an involuntary] petition, sufficient upon its face . . . clearly gives the bankruptcy court jurisdiction of the proceeding.” Emphasizing that the word “jurisdiction” does not necessarily mean “subject matter jurisdiction,” the Eleventh Circuit highlighted limiting language elsewhere in the decision that foreclosed the possibility that the Supreme Court actually meant that the involuntary petition requirements were subject matter jurisdictional. Otherwise, the Eleventh Circuit explained, failure to satisfy the requirements would divest the bankruptcy court of jurisdiction even if no party raised a challenge and even if the petition was outwardly sufficient.

Finally, in reaching its conclusion that section 303(b) does not implicate subject matter jurisdiction and that a debtor’s objection to the involuntary petition on the grounds of noncompliance with section 303(b) can therefore be waived, the Trusted Net II court held that to the extent that the former Fifth Circuit’s ruling in All Media Properties held that section 303(b)’s elements are jurisdictional, it is overruled.

Conclusion

Under the prior panel precedent rule in the Eleventh Circuit, holdings made or adopted by an earlier panel, including express jurisdictional holdings, need to be followed. However, because the Eleventh Circuit, sitting en banc, is not bound by prior decisions of a panel of the court or its predecessors (i.e., the Fifth Circuit), it is not surprising that the court used the en banc route to vacate the Trusted Net I panel’s decision, overrule All Media to the extent necessary, and adopt the majority position in Trusted Net II, especially considering, among other things, the Trusted Net I panel’s clear hesitation in its own ruling. In the end, the decision was based on what the Eleventh Circuit construed as binding Supreme Court precedent. It is important to note that the decision also helps to clarify a blurred distinction between what is purely subject matter jurisdictional and what forms the basis of a federal claim but is not jurisdictional.

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In re Trusted Net Media Holdings, LLC, 525 F.3d 1095 (11th Cir.), vacated, 530 F.3d 1363 (11th Cir.), on reh’g en banc, 550 F.3d 1035 (11th Cir. 2008).

In re Rubin, 769 F.2d 611 (9th Cir. 1985).

In re BDC 56 LLC, 330 F.3d 111 (2d Cir. 2003).

In re All Media Properties, 646 F.2d 193 (5th Cir. 1981), aff’g 5 B.R. 126 (Bankr. S.D. Tex. 1980).

Bonner v. City of Prichard, 661 F.2d 1206 (11th Cir. 1981).

Arbaugh v. Y & H Corp., 546 U.S. 500 (2006).

Canute Steamship Co. v. Pittsburgh & West Virginia Coal Co., 263 U.S. 244 (1923).
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