Fustolo v. 50 Thomas Patton Drive, LLC

• Decision Date: 24 February 2016
• Docket Number: No. 15–1340.,15–1340.
• Citation: 816 F.3d 1
• Parties: Steven C. FUSTOLO, Plaintiff, Appellant, v. 50 THOMAS PATTON DRIVE, LLC; The Patriot Group LLC; Richard Mayer, Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

816 F.3d 1

Steven C. FUSTOLO, Plaintiff, Appellant,

v.50 THOMAS PATTON DRIVE, LLC; The Patriot Group LLC; Richard Mayer, Defendants, Appellees.

No. 15–1340.

United States Court of Appeals, First Circuit.

Feb. 24, 2016.

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.

Before TORRUELLA, LYNCH,^* and KAYATTA, Circuit Judges.

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 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 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 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 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 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 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

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...