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Delaware Bankruptcy Court Sidesteps Decision on “Novel” Bar to Joinder Doctrine; Movant Failed to Demonstrate Bad Faith For Involuntary Chapter 7 Petition

In re Luxeyard, Inc., 556 B.R. 627 (Bankr. D. Del. 2016)

Declining to opine upon the “bar to joinder doctrine,” the Delaware Bankruptcy Court in this Opinion applied the Third Circuit’s “totality of the circumstances” bad faith test to deny a motion to bar the joinder of additional petitioners to an involuntary petition under Section 303(c) of the Bankruptcy Code.  Simply put, the Debtor did not carry its burden to show there was a bad faith filing, and therefore, the Court need not consider the bar to joinder doctrine.

Jinsun, LLC (“Jinsun”), whose sole manager and employee is Kevin Casey, purchased stock and convertible debentures from Luxeyard, Inc. (the alleged “Debtor”) in 2012.  Subsequently, the Debtor became a plaintiff in two Texas lawsuits against, among others, Casey and Jinsun related to the stock purchases.  The first lawsuit settled in 2012 (the “2012 Settlement”) and the second lawsuit, filed by Khaled Alattar, (the “Alattar Action”) partially settled in 2014.  Claims against Casey (among others) remain pending.  Proceeds from the Alattar Action settlement are allegedly Luxeyard’s largest asset.

On September 19, 2014, Jinsun and three other creditors (the “Original Petitioners”) filed an involuntary chapter 7 petition against Luxeyard in the Delaware Bankruptcy Court.  They asserted a claim against Luxeyard for the 2012 convertible debentures.  However, prior to trial on the Debtor’s motion to dismiss, three of the Original Petitioners settled their claims and withdrew from the involuntary petition.  With only one Original Petitioner remaining, two other creditors filed joinders under Section 303(c) so that the minimum section 303(b) requirement of three creditors for an involuntary petition was satisfied.  Under Section 303(c), creditors may join an involuntary petition before it is dismissed.  Luxeyard, however, filed a motion to bar joinder of these creditors under the judicially created “bar to joinder doctrine.”

The bar to joinder doctrine has been applied by courts to bar joinder by good faith creditors where the original petitioners knew at the time of filing that the petition did not meet the statutory requirements of Section 303(b).  The Third Circuit has not yet adopted the bar to joinder doctrine.  The Debtor here sought to extend the doctrine to the type of bad faith filing found in In re Forever Green Athletic Fields, Inc., 804 F.3d 328, 336 (3d Cir. 2015).  There, the court found that the petition itself was filed in bad faith, reasoning that the petitioner filed to obstruct and gain a tactical advantage in a pending non-bankruptcy proceeding and did not conduct a reasonable investigation prior to filing.  Our analysis of that case and the standards derived therefrom can be found here.

Addressing the Third Circuit’s eight-factor “totality of the circumstances” test, Judge Silverstein found that while Jinsun filed the petition with the improper purposes of harassing the Debtor and distracting from the Alattar Action, it also filed for the proper purpose of preventing further dissipation of Luxeyard’s assets.  Moreover, Jinsun made a “reasonable inquiry” into the facts and law by reviewing Luxeyard’s public filings and an outside audit report, consulting an attorney, and sending notice to Luxeyard that the 2012 convertible debenture had matured.  This investigation led Jinsun to conclude that proceeds from the 2012 Settlement and the Alattar Action were being distributed in a random, undocumented manner, failing to ensure that the Debtor received its fair share.  Critically, the Debtor failed to present sufficient evidence to the contrary to carry its burden on bad faith.  Likewise, the Debtor could not demonstrate that Jinsun was using the bankruptcy case to obstruct or gain a tactical advantage in the Alattar Action.  “At first blush, this case appears to test the limits of [the bad faith] boundary,” but on balance, the Court easily found that the Debtor did not meet its burden to demonstrate bad faith and denied the bar to joinder motion without reaching, or rendering a decision upon, the “novel” bar to joinder doctrine.  Op. at 35.  The Debtor’s motion to dismiss remains pending.