It is no surprise that, over the course of its 176 years, Cullen and Dykman has been called upon to advise and represent varied interests in insolvency situations, including debtors, banks, and unsecured creditors and their committees.  Confronted with an insolvency situation, clients ask us to advise as to the various remedies which are available, including bankruptcy.

“Breaking the bench” is the origin of our contemporary term “bankruptcy,” derived from the medieval practice of banca rotta – the breaking of a tradesman’s bench upon failure to pay his debts. That punitive approach was later superseded in England by the imprisonment of debtors.  The American experience, by contrast, evolved toward a system grounded in rehabilitation.

The United States Bankruptcy Act was overhauled in 1978 with the introduction of the Bankruptcy Code, which itself has been modified over the years.  However, there are other approaches to dealing with insolvency, as we have discussed in previous client alerts.[1]

On occasion there may be a clash between those who seek to use those alternative remedies and those who favor the use of the federal bankruptcy code. Alternative remedies include state court provisions like receivership or assignment for the benefit of creditors and also include out of court and informal workouts. 

Bankruptcy is an equitable proceeding. It arises out of a commitment to do justice, where debtors and their creditors with clean hands, seek to address insolvency. Because it is equitable, it recognizes exigencies and special cases, including those situations where there is a clash as to how to proceed.

The Bankruptcy Reform Act of 1978 included an abstention section, enabling courts to abstain from hearing a bankruptcy case.  Most often it is used in the case of an involuntary proceeding where there is some alternative remedy already underway. It may also be used when there is a change of heart by the debtor who files the case.

Section 305 of the Bankruptcy Code states that “[t]he court, after notice and hearing, may dismiss a case under this title, or may suspend all proceedings in a case under this title, at any time if the interests of creditors and the debtor would be better served by such dismissal or suspension. . . .”[2]

The key phrase of the statute is “the interests of creditors and the debtor.”  Courts will analyze the situation and make a determination to hear or abstain from a case based on whether it will serve both the debtor and creditors.  It is not a one-sided situation, and is determined on a case-by-case basis.[3]

Courts have generally agreed that “abstention in a properly filed bankruptcy case is an extraordinary remedy, and that dismissal is appropriate under § 305(a)(1) only in situations where the court finds that both ‘creditors and the debtor would be ‘better served’ by a dismissal.”[4]

Courts will consider several factors in making their determination.  Such factors include:

1. “The economy and efficiency of administration;
2. Whether another forum is available to protect the interests of both parties or there is already a pending proceeding in state courts;
3. Whether federal proceedings are necessary to reach a just and equitable solution;
4. Whether there is an alternative means of achieving an equitable distribution of assets;
5. Whether the debtor and the creditors are able to work out a less expensive out-of-court arrangement which better serves all interests in the case;
6. Whether a non-federal insolvency has proceeded so far in those proceedings that it would be costly and time consuming to start afresh with the federal bankruptcy process; and
7. The purpose for which bankruptcy jurisdiction has been sought.”[5]

A recent case from the Bankruptcy Court for the Southern District of New York addressed these factors and found that abstention was not in the best interests of the debtor and creditors.

In In re Nogin Commerce LLC, the Debtor operated an e-commerce platform for various companies.  The Debtor assigned its assets for the benefit of creditors under New York law to an assignee and four creditors filed an involuntary chapter 7 petition against the Debtor.  The Assignee filed a motion to dismiss the bankruptcy case or abstain, arguing that the interest of creditors would be better served in the assignment proceeding under New York law.[6]

Judge Martin Glenn, Chief United States Bankruptcy Judge for the Southern District of New York disagreed.  The Court held that abstention was not warranted finding that “the Court can offer an efficient means for addressing the claims of the Alleged Debtor’s estate in a just and equitable fashion. . ., [and] a bankruptcy’s nationwide automatic stay. . . can aid in preserving and maximizing value for the Alleged Debtor’s estate and its creditors”.[7]  Additionally, the Court reasoned that although the “Assignment Proceeding is already pending in state court and can offer an alternative means of distribution of assets, it is unclear that the Assignee has sufficiently accounted for the interests of all creditors to do so in an equitable manner.”[8] Further, the Court explained that the petitioning creditors represented that they filed the involuntary petition to “take advantage of the benefits that bankruptcy offers” and that nothing substantial had occurred in the Assignment Proceeding so that it would be costly to “start afresh” in the bankruptcy court.[9]

In a situation where a debtor has not paid a creditor for months, the creditor may seek appointment of a state court receiver.  Subsequently, other creditors may file an involuntary bankruptcy.[10]

The debtor may respond to the involuntary petition by seeking an order (i) to dismiss the involuntary petition with prejudice, pursuant to section 303(h), 305(a) and 707 of the United States Bankruptcy Code, or, alternatively, (ii) to abstain from consideration of the involuntary petition pursuant to section 305(a) of the Bankruptcy Code and/or exercise its discretion to permissively abstain from hearing the involuntary case pursuant to Judiciary Code section 1334(c).

Consideration by the Court will be as to whether the bankruptcy court is the most economical and efficient forum to resolve the dispute.  For example, is discharge or automatic stay[11] protection needed?  Can the state court provide all the protection needed?  Is the state court the most economical and efficient forum in which to resolve the creditor’s dispute with the alleged debtor?  Have creditors demonstrated why they cannot obtain the same relief in state court?  All these considerations will be addressed when deciding abstention issues.

Although the court will address these factors on a case-by-case basis as we have illustrated, the underlying theme will always be what is just and equitable for all involved.

Please note this is a general overview of developments in the law and does not constitute legal advice.  Nothing herein creates an attorney-client relationship between the sender and the recipient.  If you have any questions regarding the provisions discussed above, or any other aspect of bankruptcy law, please contact Michael H. Traison, Esq. (mtraison@cullenllp.com) at 312.860.4230 or Kelly McNamee, Esq. (kmcnamee@cullenllp.com) at 516.296.9166.

Footnotes

[1] Insolvency: Alternative Remedies

[2] 11 U.S.C. § 305.

[3] In re 318 Retail, LLC, 642 B.R. 884, 886 (Bankr. N.D. Ill. 2022).

[4] In re Monitor Single Lift I, Ltd., 381 B.R. 455, 462 (Bankr. S.D.N.Y. 2008) (internal citations omitted).

[5] Id. at 464-65.

[6] In re Nogin Commerce LLC, 670 B.R. 711, 733 (Bankr. S.D.N.Y. 2025).

[7] Id. at 733.

[8] Id.

[9] Id.

[10] Be Wary of Using Involuntary Bankruptcy as a Collection Tool; Be Wary of Using Involuntary Bankruptcy as a Collection Tool: An Update; Involuntary Petitions in Bankruptcy: a Brief Update.

[11] Why Is This Injunction Different From All Other Injunctions? The Automatic Stay, An Update.