Fustolo v. 50 Thomas Patton Drive, LLC

United States Court of Appeals
For the First Circuit
No. 15-1340
STEVEN C. FUSTOLO,
Plaintiff, Appellant,
v.
50 THOMAS PATTON DRIVE, LLC; THE PATRIOT GROUP LLC;
RICHARD MAYER,
Defendants, Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Rya W. Zobel, U.S. District Judge]
Before
Torruella, Lynch,* and Kayatta,
Circuit Judges.
David M. Nickless, with whom Nickless, Phillips and O'Connor,
was on brief for appellant.
Michael J. Fencer, with whom Howard P. Blatchford, Jonathan
M. Horne, and Jager Smith P.C., were on brief, for appellees 50
Thomas Patton Drive, LLC, and Richard Mayer.
Colleen C. Cook, with whom Michael Paris, Jack I. Siegal, and
Nystrom Beckman & Paris LLP, were on brief, for appellee The
Patriot Group LLC.
* Judge Lynch heard oral argument in this matter and
participated in the semble, but she did not participate in the
issuance of the panel's opinion. The remaining two panelists issue
this opinion pursuant to 28 U.S.C. § 46(d).
February 24, 2016
KAYATTA, Circuit Judge. We hold in this case that a
claim to payment that 50 Thomas Patton Drive, LLC ("Patton Drive")
holds against Steven Fustolo ("Fustolo") "is not contingent as to
liability or the subject of a bona fide dispute as to liability or
amount" within the meaning of section 303(b)(1) of the Bankruptcy
Code. 11 U.S.C. § 303(b)(1). We therefore affirm the decision of
the bankruptcy court, which found Patton Drive qualified to join
with two other creditors also holding non-contingent, undisputed
claims to force Fustolo into an involuntary bankruptcy proceeding.
I.
Patton Drive's claims against Fustolo arise out of four
promissory notes issued to Patton Drive by Fustolo's affiliate
companies in connection with two real estate transactions. Fustolo
personally guaranteed two of the notes (the "Guaranteed Notes"),
which together totaled $1.25 million, but did not guarantee the
other two notes (the "Unguaranteed Notes"), which together totaled
$1.5 million. When the principal debtors defaulted on all four
notes, Patton Drive sued the debtor companies and Fustolo,
asserting that Fustolo was personally liable on his guarantee.
The Massachusetts state court found Fustolo liable for breach of
contract and rejected Fustolo's argument that Patton Drive's
technical violation of a state usury statute should reduce the
amount of interest owed on the notes. The court entered a final
judgment against Fustolo in favor of Patton Drive in the amount of
- 3 -
roughly $6.76 million.1 Fustolo contends that this judgment
overstated his liability by approximately $4 million because it
erroneously assumed that he had guaranteed all of the notes. In
response, Patton Drive demurs, declining to offer any defense of
the state court's damages calculation. Fustolo lodged a timely
appeal of the state court judgment but did nothing further to
prosecute the appeal, which we are told has rested more or less
dormant on the state court's appellate docket for at least four
years.
Meanwhile, Fustolo, who admittedly has at least twelve
creditors, failed to satisfy his financial obligations to at least
two of those other creditors, The Patriot Group LLC ("Patriot")
and Richard Mayer ("Mayer"). On May 6, 2013, eighteen months after
entry of the state court judgment, Patton Drive joined with Patriot
and Mayer to file a petition with the United States Bankruptcy
Court, seeking to place Fustolo into involuntary Chapter 7
bankruptcy, and to thereby cause Fustolo's debts to be determined
1 The court also found, inter alia, that Fustolo and his
affiliates had violated a state statute by engaging in unfair and
deceptive business practices. See Mass. Gen. Laws ch. 93A, §§ 2,
11. The parties dispute whether Fustolo was assigned any
independent monetary liability for this violation, but it is
undisputed that the judgment held all defendants jointly and
severally liable for attorneys' fees and costs as to this and other
counts.
- 4 -
and his assets gathered and liquidated in an orderly fashion to
satisfy those debts. See 11 U.S.C. §§ 303(b)(1), 701 et seq.
The creditors' ability to force Fustolo into bankruptcy
rests on 11 U.S.C. § 303(b)(1), which provides that involuntary
bankruptcy proceedings may be commenced via petition to the
bankruptcy court
by three or more entities, each of which is
. . . a holder of a claim against [the debtor]
that is not contingent as to liability or the
subject of a bona fide dispute as to liability
or amount . . . if such noncontingent,
undisputed claims aggregate at least
[$14,425] more than the value of any lien on
property of the debtor securing such claims
held by the holders of such claims.
11 U.S.C. § 303(b)(1); see also id. § 104(a). Fustolo does not
dispute that Patriot and Mayer hold eligible claims against him.
Nor does Fustolo dispute that the total amount of those undisputed
claims exceeds the value of any related liens on his property by
the statutorily requisite amount. However, Fustolo maintains that
Patton Drive has not asserted a claim that qualifies it to serve
as a petitioning creditor because his pending state court appeal
subjects Patton Drive's judgment to "bona fide dispute as to
liability or amount." Id. § 303(b)(1).
Following an evidentiary hearing in the bankruptcy court
on Fustolo's challenge to their qualifications to initiate an
involuntary proceeding, the three petitioning creditors moved for
summary judgment. Fustolo opposed the motion and filed his own
- 5 -
cross-motion for summary judgment. On December 16, 2013, the
bankruptcy court granted summary judgment to the petitioning
creditors, thus authorizing involuntary bankruptcy proceedings to
commence against Fustolo.
In assessing whether Patton Drive's state court judgment
constituted a qualifying claim despite Fustolo's appeal, the
bankruptcy court employed the approach approved by the Fourth
Circuit in In re Byrd, 357 F.3d 433 (4th Cir. 2004). Under this
approach, the court did not accord the state court judgment against
Fustolo dispositive force in establishing the absence of a bona
fide dispute concerning the right to payment recognized and
affirmed in that judgment. Instead, the court began with a
presumption that the judgment foreclosed any bona fide dispute,
but then proceeded to assess the merits of Fustolo's pending state
court appeal to determine whether Fustolo's case "exemplifie[d]
the rare circumstance where the amount of the judgment is in bona
fide dispute." Upon examination, the court found a bona fide
dispute as to the portion of the judgment that awarded damages
against Fustolo on the Unguaranteed Notes because, among other
things, Patton Drive did not oppose the contention that it had no
right to recover against Fustolo on those notes. At the same time,
the bankruptcy court separately assessed Patton Drive's right to
payment on the portion of the state court judgment that covered
Fustolo's breach of contract on the Guaranteed Notes. Finding
- 6 -
this portion of the judgment free of bona fide dispute, the
bankruptcy court granted summary judgment to Fustolo's creditors
and denied Fustolo's cross-motion.
Fustolo then appealed to the district court and found
himself jumping from the frying pan into the fire. The district
court eschewed the Fourth Circuit's merits-based analysis of the
preclusive effect of an appealed state court judgment, opting
instead for the approach announced in In re Drexler, 56 B.R. 960(Bankr. S.D.N.Y. 1986), and adopted by the only other circuit court
to have decided this issue, see In re Marciano, 708 F.3d 1123,
1124 (9th Cir. 2013). Under the so-called Drexler rule, an
unstayed state court judgment, whether or not subject to appeal,
per se constitutes a claim that is not subject to bona fide
dispute. See Drexler, 56 B.R. at 967. Therefore finding that
Fustolo's appeal in state court, however meritorious, could not
raise a bona fide dispute as to Patton Drive's claim, the district
court affirmed the bankruptcy court's order.
Fustolo now appeals to this court pursuant to 28 U.S.C.
§ 158(d)(1),2 urging us, first, to reject the district court's
2 Although no party addresses whether a bankruptcy court's
order for relief in favor of a petitioning creditor in an
involuntary suit is the sort of final order over which this court
has appellate jurisdiction, we follow our sister circuits in
finding no apparent impediment. See In re HealthTrio, Inc., 653
F.3d 1154, 1160 (10th Cir. 2011); In re McGinnis, 296 F.3d 730,
731 (8th Cir. 2002) (per curiam); In re Mason, 709 F.2d 1313, 1315–
18 (9th Cir. 1983); see also Bullard v. Blue Hills Bank, 135 S.
- 7 -
decision to apply Drexler's categorical rule and, second, to reject
the bankruptcy court's determination that, even under Byrd's more
debtor-friendly burden-shifting rule, Patton Drive qualifies as a
petitioning creditor because it holds a claim on the Guaranteed
Notes that is free of bona fide dispute. For slightly different
reasons, we affirm.
II.
A.
In bankruptcy proceedings, summary judgment is
appropriate when the movant has shown that there is no genuine
dispute as to any material fact and that the movant is entitled to
judgment as a matter of law. Fed. R. Bankr. P. 7056; Fed. R. Civ.
P. 56(a). We review the bankruptcy court's grant of summary
judgment de novo. In re Colarusso, 382 F.3d 51, 57–58 (1st Cir.
2004). In undertaking this review, we afford no deference to the
district court's intermediate decision. In re Healthco Int'l,
Inc., 132 F.3d 104, 107 (1st Cir. 1997).
B.
We begin with the creditors' argument that we can easily
resolve this appeal by adopting the district court's conclusion
that the Drexler rule applies and that Patton Drive's claim is
Ct. 1686, 1695 (2015) (suggesting that a bankruptcy court order
that "allows the bankruptcy to go forward and alters the legal
relationships among the parties" is appealable).
- 8 -
therefore categorically free from bona fide dispute. If the
creditors are correct on this point, we need not--and indeed
cannot--look behind the state court judgment to assess its merits.
On the facts of this case, however, we cannot hold that the Drexler
rule applies.
The Drexler rule, followed by the Ninth Circuit, see
Marciano, 708 F.3d at 1124, has much to commend it. It is simple
to apply, and it reduces the waste of assets inherent in opening
the opportunity for a financially troubled party to argue the
merits of issues previously adjudicated in state court. It also
arguably accords to a state court judgment the sort of respect and
finality reflected in the Full Faith and Credit Act, which requires
that federal courts give state court judgments "the same full faith
and credit . . . as they have by law or usage in the courts of
such State . . . from which they are taken." 28 U.S.C. § 1738;
see also Marciano, 708 F.3d at 1128.3
3 The creditors take this observation one step further and
argue that 28 U.S.C. § 1738 fully estops Fustolo from arguing the
existence of a bona fide dispute as to the state court judgment in
light of the fact that, under Massachusetts law, "a trial court
judgment is final and has preclusive effect regardless of the fact
that it is on appeal." O'Brien v. Hanover Ins. Co., 692 N.E.2d
39, 44 (Mass. 1998). Fustolo, though, does not ask us in this
litigation to reject the fact or legal effect of the state court
judgment. Rather, he seeks only to establish that the amount of
his liability is subject to bona fide dispute. See Marciano, 708
F.3d at 1134 (Ikuta, J., dissenting) ("[D]etermining whether a
claim based on a state court judgment is subject to a bona fide
dispute does not require us to [decide anew] any issue [already]
decided in a state court proceeding."). And we have found no
- 9 -
More importantly, the Drexler rule fits with Congress's
apparent purpose in requiring each claim underlying an involuntary
petition to be free of "bona fide dispute." In usual course,
bankruptcy serves as a haven for debtors seeking protection from
creditors and hoping to make a fresh start. See In re Fahey, 779
F.3d 1, 8–9 (1st Cir. 2015). But the Bankruptcy Code also serves
another, "often conflicting," purpose: to "ensure fair payment to
creditors." In re Energy Res. Co., 871 F.2d 223, 230 (1st Cir.
1989). Section 303 of the Bankruptcy Code thus allows creditors
who satisfy certain conditions to force a debtor into bankruptcy,
so that the disposition of the debtor's assets can proceed in a
more orderly fashion.
The requirement that the petitioning creditors' claims
be free of bona fide dispute was added by the Bankruptcy Amendments
and Federal Judgeship Act of 1984, Pub. L. No. 98-353, § 426(b),
98 Stat. 333, 369. The Bankruptcy Code does not define the term
"bona fide dispute," but courts have more or less settled on
finding a bona fide dispute when "there is either a genuine issue
of material fact that bears upon the debtor's liability or a
meritorious contention as to the application of law to undisputed
facts." In re BDC 56 LLC, 330 F.3d 111, 117 (2d Cir. 2003) (citing
Massachusetts precedent suggesting that the existence of a
judgment estops a litigant from arguing that the judgment is
persuasively contested.
- 10 -
cases), abrogated on other grounds as recognized in In re Zarnel,
619 F.3d 156, 169 (2d Cir. 2010). The self-evident purpose of the
"no bona fide dispute" requirement, as courts have repeatedly
recognized, is "to prevent creditors from using involuntary
bankruptcy 'to coerce a debtor to satisfy a judgment even when
substantial questions may remain concerning the liability of the
debtor.'" Byrd, 357 F.3d at 438 (quoting In re Prisuta, 121 B.R.
474, 476 (Bankr. W.D. Pa. 1990)); see also BDC 56 LLC, 330 F.3d at117–18; In re Tikijian, 76 B.R. 304, 313–14 (Bankr. S.D.N.Y. 1987)
("It was stated by the proponent of the [1984] amendment . . .
that the primary purpose of the addition of the bona fide dispute
language was to prevent creditors from using involuntary
bankruptcy as a club to coerce a debtor to pay debts as to which
the debtor, in good faith, had legitimate defenses."). With that
purpose in mind, courts generally try to determine whether,
objectively, there is a dispute about a debt that reasonably
warrants resolution by a factfinder or, in the case of a dispute
of law, a court. See In re Busick, 831 F.2d 745, 750 (7th Cir.
1987) ("[T]he bankruptcy court must determine whether there is an
objective basis for either a factual or a legal dispute as to the
validity of debt."). When such a dispute exists, we do not allow
the creditor to coerce the debtor's surrender by credibly
threatening to use the claim as a basis for an involuntary
petition.
- 11 -
But when the creditor already holds a state court
judgment upon which execution is possible, allowing the creditor
to join in forcing a bankruptcy proceeding adds little material
weight to the creditor's ability to coerce payment of the debt.
The absence of a stay also undercuts the debtor's ability to argue
that the state courts view the debt as not quite collectable.
Consistent with these reasons, the Drexler rule applies only to
"unstayed" state court judgments--those judgments that actually
entitle a creditor to access the debtor's assets. Drexler, 56
B.R. at 967 n.11; see also, e.g., In re Raymark Indus., Inc., 99
B.R. 298, 299–300 (Bankr. E.D. Pa. 1989).
Turning to the instant case, a Massachusetts trial
court's judgment is effectively stayed by operation of state law
for the purposes of execution, even absent a court order, while an
appeal is pending. See Mass. Gen. Laws ch. 231, § 115; id. ch.
235, § 16; Mass. R. Civ. P. 62(a). Thus, Patton Drive could not
execute in Massachusetts courts on its judgment. See, e.g., C.F.
Tr., Inc. v. Peterson, No. 961375H, 1998 WL 1284163, at *2–3 (Mass.
Super. Ct. May 21, 1998) (refusing execution on a confessed
judgment on a promissory note pending debtors' appeal).4
4 The creditors have offered no argument that Massachusetts
law provides an equitable exception for appeals that have stagnated
as long as Fustolo's has, and so we consider any such argument
waived without fully foreclosing the possible existence of a state
law exception. See United States v. Zannino, 895 F.2d 1, 17 (1st
Cir. 1990).
- 12 -
The courts below treated this wrinkle as inconsequential
in light of the fact that Massachusetts law does not automatically
stay the other legal effects of a judgment pending appeal. In
particular, the courts below held that Patton Drive's state court
judgment is unstayed because of the availability of postjudgment
discovery and attachment under Massachusetts law regardless of a
pending appeal. See A.W. Farrell Assocs., LLP v. Haddon, No. 07-
P-596, 2008 WL 4130828, at *3–4 (Mass. App. Ct. Sept. 9, 2008)
(unpublished opinion) (discovery); Borne v. Haverhill Golf &
Country Club, 791 N.E.2d 903, 919 (Mass. App. Ct. 2003)
(attachment). But these tools would have been available to Patton
Drive even prior to the judgment that fixed its rights. See Mass.
R. Civ. P. 4.1 (prejudgment attachment); id. 26 (discovery). And
the fact that a trial court's judgment is stayed in some senses
under Massachusetts law pending appeal, while remaining unstayed
in others, does not by itself tell us whether the judgment is
stayed or unstayed for the purposes of the Drexler rule.
We are not persuaded that a judgment is unstayed for
bankruptcy purposes merely because that judgment continues to have
some legal effects despite a creditor's legal inability to execute.
The Bankruptcy Code defines a "claim" as, in relevant part, a
"right to payment." 11 U.S.C. § 101(5)(A) (emphasis supplied).
And in construing the requirement that such a claim be free from
bona fide dispute, courts applying the Drexler rule have focused
- 13 -
not on the abstract existence of a legal right, but rather on the
claim-holder's ability to vindicate that right in court. See,
e.g., Marciano, 708 F.3d at 1127 (no bona fide dispute when
"Petitioning Creditors were free under California law to collect
the amounts owed under the judgments at the time the involuntary
petition was filed" (emphasis supplied)); id. at 1131 (Ikuta, J.,
dissenting) ("The majority's reasoning seems to be that . . .
because an unstayed state court judgment is immediately
enforceable, there can be no objective basis for dispute as to the
'claim's' liability or amount." (emphasis supplied)); Drexler, 56
B.R. at 967 (unstayed state court judgment not subject to bona
fide dispute because a contrary holding would "effect a radical
alteration of[] the long-standing enforceability of unstayed final
judgments" (emphasis supplied)). Because the ability to execute
on a state court judgment provides a crucial link in the rationale
that justifies the bright line, automatic nature of the Drexler
rule, we find that rule inapplicable when, as here, execution on
the judgment is stayed, even if only by automatic operation of
state law.5 Patton Drive's state court judgment is therefore not
categorically insulated from bona fide dispute.
5 We leave open the question of whether the Drexler rule would
apply in the event of an unstayed state court judgment that has
been appealed.
- 14 -
C.
Even though a state court judgment does not necessarily
establish the absence of bona fide dispute when that judgment is
effectively stayed, the judgment must nevertheless play some role
in our analysis. The fact that a state court has already
considered and adjudicated the merits of a claim, and entered
judgment on the claim, weighs heavily in favor of finding the claim
beyond bona fide dispute. See Byrd, 357 F.3d at 438 (state court
judgments were "strong evidence that [the creditor's] claims were
valid"). This observation is particularly salient where the
judgment is stayed by virtue of the automatic operation of state
law and not because a state court has probed the merits of the
judgment and found reason to suspect that it may be incorrect.
But despite the weight we would normally attach to a
state court judgment, here we have a judgment that appears on its
face to be in error because it holds Fustolo personally liable for
roughly $4 million on the Unguaranteed Notes and, notably, Patton
Drive as the holder of the judgment offers no reason at all to
think otherwise. As the bankruptcy court recognized, Patton
Drive's de facto concession on this point certainly creates a bona
fide dispute as to the amount of Patton Drive's right to payment
on the judgment.
As Patton Drive points out, however, the dispute over
the judgment concerns only a portion of the judgment. Fustolo
- 15 -
makes no real effort to deny that he owes, at least, the principal
due under the Guaranteed Notes, which totals $1.25 million.6 Based
on this concession, Patton Drive asks us to rule that any dispute
concerning the amount of the liability represented by the judgment
can be ignored, because the amount admittedly owed well exceeds
the amount necessary to justify Patton Drive's joinder as a
petitioning creditor under 11 U.S.C. § 303(b)(1).
In making this argument, the creditors essentially ask
us to read an implicit materiality requirement into the statutory
language "bona fide dispute as to liability or amount." 11 U.S.C.
§ 303(b)(1). Prior to 2005, some courts had held--as the
bankruptcy court held here--that a claim to a disputed amount could
nevertheless form the basis of an involuntary petition if the
undisputed portion of the claim could independently qualify the
creditor. See, e.g., In re Focus Media, Inc., 378 F.3d 916, 925–
27 (9th Cir. 2004); BDC 56 LLC, 330 F.3d at 120; IBM Credit Corp.
v. Compuhouse Sys., Inc., 179 B.R. 474, 479 (W.D. Pa. 1995); In re
Willow Lake Partners II, L.P., 156 B.R. 638, 642–43 (Bankr. W.D.
6Fustolo makes a fleeting intimation in his brief that, under
Begelfer v. Najarian, 409 N.E.2d 167 (Mass. 1980), Patton Drive's
failure to comply with state usury law should relieve him of his
debt even on the Guaranteed Notes' unpaid principal, see id. at
173–74. But Fustolo supplies this court with no developed reason
to entertain such a farfetched argument, and so any effort to claim
that Fustolo's liability on the Guaranteed Notes' principal is
subject to bona fide dispute is waived for lack of development.
See Zannino, 895 F.2d at 17.
- 16 -
Mo. 1993). In 2005, however, Congress amended section 303 to add
the language "as to liability or amount." Bankruptcy Abuse
Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-
8, § 1234, 119 Stat. 23, 204. Faced with a dearth of clarifying
legislative history, courts are more or less evenly split on
whether the 2005 amendment was intended to change the prevailing
law by establishing that "a dispute as to any portion of a claim,
even if some dollar amount would be left undisputed, means there
is a bona fide dispute as to the amount of the claim," In re Vicor
Techs., Inc., No. 12-39329, 2013 WL 1397460, at *5 (Bankr. S.D.
Fla. Apr. 5, 2013), or simply to reinforce the then-prevailing
interpretation, see In re DemirCo Holdings, Inc., No. 06-70122,
2006 WL 1663237, at *3 (Bankr. C.D. Ill. June 9, 2006) (a dispute
as to amount is immaterial unless it "ha[s] the potential to reduce
the total of [the petitioning creditors'] claims to an amount below
the statutory threshold.").7
7 Compare, e.g., Vicor, 2013 WL 1397460, at *5; In re Skyworks
Ventures, Inc., 431 B.R. 573, 578 n.1 (Bankr. D.N.J. 2010); In re
Rosenberg, 414 B.R. 826, 845–46 (Bankr. S.D. Fla. 2009); In re
Excavation, Etc. LLC, No. 09-60953, 2009 WL 1871682, at *2 (Bankr.
D. Or. June 24, 2009); In re Metro Cremo & Sons, Inc., No. 1:08-
bk-01798, 2008 WL 5158288, at *4 n.8 (M.D. Pa. Sept. 29, 2008); In
re Mountain Dairies, Inc., 372 B.R. 623, 634 (Bankr. S.D.N.Y.
2007); In re Reg'l Anesthesia Assocs. PC, 360 B.R. 466, 469–70
(Bankr. W.D. Pa. 2007); In re Euro-Am. Lodging Corp., 357 B.R.
700, 712 n.8 (Bankr. S.D.N.Y. 2007) (no materiality requirement),
with, e.g., In re Stewart, Nos. 14-03177, 14-03179, 2015 WL
1282971, at *6 (Bankr. S.D. Ala. Mar. 18, 2015); In re EM Equip.,
LLC, 504 B.R. 8, 18 (Bankr. D. Conn. 2013); In re Roselli, No. 12-
32461, 2013 WL 828304, at *9 (Bankr. W.D.N.C. Mar. 6, 2013); In re
- 17 -
We decline to read a materiality requirement into
section 303. As discussed above, the bona fide dispute provision
strikes a balance between the Bankruptcy Code's dual purposes of
ensuring the orderly disposition of creditors' claims and
protecting debtors from coercive tactics. See supra Part II.B.
Limiting petitioning creditors to only those claims that are of
undisputed value is in line with those aims. Accordingly, and in
the absence of persuasive contrary authority or illuminating
legislative history, we follow the straightforward reading of
section 303, which places no qualifiers on the requirement that
any asserted claim be free of "bona fide dispute as to . . .
amount."
D.
Our conclusions that this judgment upon which execution
is stayed under Massachusetts law is not categorically insulated
from bona fide dispute, that there exists a bona fide dispute as
to the amount that will ultimately be due under the judgment, and
that a dispute as to amount need not be material to generate a
disqualifying bona fide dispute under 11 U.S.C. § 303(b)(1), bring
us to Patton Drive's last, two-part argument: First, Patton Drive
Miller, 489 B.R. 74, 82–83 (Bankr. E.D. Tenn. 2013); In re Mountain
Country Partners, LLC, No. 12-20094, 2012 WL 2394714, at *3 (Bankr.
S.D. W. Va. June 25, 2012); In re Tucker, No. 5:09-bk-914, 2010 WL
4823917, at *6 (Bankr. N.D. W. Va. Nov. 22, 2010); DemirCo, 2006
WL 1663237, at *3 (requiring materiality).
- 18 -
contends that we should look beneath the state court judgment to
the underlying contract claims that gave rise to the judgment and
treat its right to payment on the Guaranteed Notes as its
qualifying claim. Second, Patton Drive asks us to find that
Fustolo's efforts to contest the interest due on the Guaranteed
Notes do not suffice to subject its claim on those notes to bona
fide dispute as to amount. We address these arguments in turn.
1.
To consider the claim on the Guaranteed Notes as the
claim held by Patton Drive that qualifies it as a petitioner under
section 303(b)(1), we first confront Fustolo's contention that
Patton Drive's claim on the Guaranteed Notes no longer exists
because it merged into and became part of the state court judgment.
Hence, in Fustolo's view, our conclusion that the judgment itself
is subject to a bona fide dispute ends the relevant inquiry. We
do not doubt that a merger of this type can occur. See Restatement
(Second) of Judgments § 18, cmt. a ("When the plaintiff recovers
a valid and final personal judgment, his original claim is
extinguished and rights upon the judgment are substituted for
it."). But we also see no reason to view such a merger as operative
in all contexts. Cf. Boynton v. Ball, 121 U.S. 457, 466 (1887)
("[N]otwithstanding the change in [a debt's] form from that of a
simple contract debt . . . by merger into a judgment of a court of
record, it still remains the same debt[.]"); In re Richard A.
- 19 -
Turner Co., 209 B.R. 177, 180 (Bankr. D. Mass. 1997) (separating
a single, jointly held judgment into its three underlying component
claims and so finding that the judgment-holders qualified as
petitioning creditors). Here, for instance, Fustolo should not be
allowed to argue, on the one hand, that the judgment is not final
for purposes of establishing that Patton Drive's claim on the
judgment is subject to bona fide dispute, yet argue, on the other
hand, that we should treat the judgment as final for purposes of
displacing the underlying contract claims. Once we have already,
to Fustolo's advantage, looked beneath the surface of the state
court judgment in order to identify its vulnerable components, we
see no principled reason to then ignore what is, but for the
potential operation of merger, an independent claim capable of
standing on its own merits.
Alternatively, Fustolo argues that even if Patton Drive
could have asserted only its claim under the Guaranteed Notes as
its qualifying claim in the petition, it did not do so. Rather,
the involuntary bankruptcy petition asserts as Patton Drive's
claim the entire state court judgment. This is true. But Fustolo
concededly knew from the start that the liability represented by
the judgment consisted of two separate components, one of which
was the liability under the Guaranteed Notes. Indeed, in Fustolo's
initial answer to the involuntary petition, Fustolo contested the
state court's calculation of the amount of interest due on the
- 20 -
Guaranteed Notes specifically, and Fustolo has continued to raise
this argument throughout the litigation. Patton Drive's
memorandum in support of summary judgment before the bankruptcy
court, in turn, made clear that Patton Drive understood the state
court judgment to "encompass[] . . . separate damages components,"
one of which was Fustolo's liability on the Guaranteed Notes.
Fustolo gives us no reason to think that his strategy would have
changed had Patton Drive asserted only its claim under the
Guaranteed Notes from the outset.
Certainly, Patton Drive could have sought to formally
amend the claim it asserted in its involuntary petition. See Fed.
R. Bankr. P. 7015; see also id. 1018; Fed. R. Civ. P. 15. But
given that Patton Drive had no way of knowing how the bankruptcy
court would rule on the preclusive effect of the state court
judgment or on the issue of merger, and given that Fustolo's
liability on the Guaranteed Notes formed an obvious, separately
calculated amount within the asserted claim, we cannot fault Patton
Drive for failing to do so. Accordingly, we hold that a
petitioning creditor may be permitted to rely on an undisputed
component claim that underlies a disputed multi-part judgment that
the creditor has asserted as its qualifying claim, where the amount
of that undisputed claim is clearly severable from the amount of
the total judgment and where the debtor both has notice of that
reliance and is not prejudiced by that reliance. See In re
- 21 -
Cumberland Farms, Inc., 284 F.3d 216, 226 (1st Cir. 2002) ("Under
the liberal pleading regime prescribed by the Federal Rules of
Civil Procedure, non-compliance with . . . procedural rules does
not always preclude consideration of unpleaded claims . . . .").
2.
Our decision that neither merger of the claim on the
Guaranteed Notes into the judgment nor Patton Drive's assertion of
the state court judgment in the petition precludes Patton Drive
from relying only on the claim under the Guaranteed Notes to
qualify it as a petitioning creditor brings us to the second part
of Patton Drive's two-part argument: whether the claim under the
Guaranteed Notes is indeed free of bona fide dispute. Fustolo
argues that the $2.7 million due on the Guaranteed Notes is
disputed as to amount, claiming that Patton Drive is not entitled
to the Guaranteed Notes' full default interest rate of 35% because
Patton Drive failed to timely submit a required "usury notification
form" to the state attorney general before levying interest rates
in excess of 20%. Mass. Gen. Laws ch. 271, § 49(d); see also Clean
Harbors, Inc. v. John Hancock Life Ins. Co., 833 N.E.2d 611, 625
(Mass. App. Ct. 2005) (requiring usury notice to be on file with
state attorney general before disbursal of loan proceeds). But
under Massachusetts law, "[t]he appropriate remedy" to a violation
of the usury statute
- 22 -
is arrived at by balancing a number of factors
including the importance of the public policy
against usury, whether a refusal to enforce
the [usurious] term will further that policy,
the gravity of the misconduct involved, the
materiality of the provision to the rest of
the contract, and the impact of the remedy on
the parties' rights and duties.
Begelfer v. Najarian, 409 N.E.2d 167, 189 (Mass. 1980).
"[D]etermining what relief is appropriate, if any," is a matter up
to "the [trial] judge's discretion, under equitable principles."
Clean Harbors, 833 N.E.2d at 625 (emphasis supplied) (noting that
"the de minimis nature of the delay in filing the [statutorily
required usury] notices" may be a factor in determining remedy).
Given the discretion that state law affords trial courts in this
matter, and given the state trial court's cogent explanation for
its determination that Patton Drive was entitled to the full
default interest rate on the Guaranteed Notes despite its technical
violation of the usury statute, Fustolo has failed to overcome our
strong presumption that state court findings, even when not
categorically binding, are free of bona fide dispute.
Because the amount of Fustolo's liability on the
Guaranteed Notes, which formed separately delineated counts of the
state court judgment, is not subject to bona fide dispute, and
because there is no injustice in considering Patton Drive's claim
on the Guaranteed Notes separately from Patton Drive's claim on
the judgment within which its underlying contract claims are
- 23 -
submerged, we find that Patton Drive qualifies as a petitioning
creditor and that the bankruptcy court therefore did not err in
allowing Patton Drive to join with Patriot and Mayer to initiate
involuntary bankruptcy proceedings against Fustolo.
Conclusion
To summarize: Patton Drive holds a claim against Fustolo
for $2.7 million under the Guaranteed Notes. Fustolo conceded
that he owes the principal due. His only challenge is to the
interest due, and that challenge rests on an entirely unsupported
assertion that a state trial court abused its broad equitable
discretion in not penalizing a technical timing requirement of
state usury law in a commercial transaction. And while Patton
Drive's claim would otherwise be merged into a final judgment, in
this context--to Fustolo's benefit otherwise--we do not accord the
judgment its customary finality and effect. Accordingly, we affirm
the bankruptcy court's grant of summary judgment to Fustolo's
creditors.
- 24 -