In re QDOS, Inc. (9th Cir. BAP)

The following is a case update written by Everett L. Green, an attorney with the U.S. Department of Justice, Office of the United States Trustee analyzing a recent decision of interest:

The Ninth Circuit Bankruptcy Appellate Panel Reverses Bankruptcy Court Because The Court Did Not Require The Filing Of A List of Creditors And Did Not Give An Opportunity For Other Creditors to Join To Meet the Numerosity Requirement. In re QDOS, Inc., Ninth Circuit BAP # CC 18-1301, 2019 WL 5808794 Nov. 7, 2019.

To view the full opinion click here.

FACTS

In QDOS, the bankruptcy court joined the majority of courts in concluding that a dispute as to the amount of a claim held by a creditor disqualifies the creditor from qualifying as a petitioning creditor to commence an involuntary bankruptcy case under Section 303.

The appellate court, however, spent the bulk of its decision evaluating whether the bankruptcy court applied the proper procedures under Section 303.

By way of background, Section 303 authorizes the filing of an involuntary petition against a corporation. 11 U.S.C. § 303(a). When the petition is not contested, the bankruptcy court enters an order for relief, and the bankruptcy case proceeds. 11 U.S.C. § 303(h). But corporations can resist the involuntary petition, and the Code provides for standards and procedures that govern the resulting decisional process.

When an involuntary petition is contested, the petitioning creditors must show that the involuntary debtor is in actual financial distress; they may meet this requirement by establishing that the involuntary debtor is not paying its undisputed debts as they come due. 11 U.S.C. § 303(h)(1).

Petitioning creditors must also show that there is sufficient desire for an involuntary bankruptcy on the part of undisputed creditors; in a case with fewer than 12 creditors, a single qualified creditor suffices, but, where the debtor has a larger creditor body, three qualified creditors must petition for involuntary relief. 11 U.S.C. § 303(b)(1), (2). Petitioning creditors bear the burden of proof on both of these issues. Cunningham v. Rothery (In re Rothery), 143 F.3d 546, 548 (9th Cir. 1998).

REASONING

An involuntary debtor may initially contest the involuntary petition through a Rule 12(b)(6) motion. But in many cases, a bankruptcy court will not be able to dismiss an involuntary case solely on a motion to dismiss. If the petitioning creditors plausibly allege that they have met the standards, the motion must fail, and the involuntary debtor must file an answer and file a list. Where a trial is required for resolution the debtor must answer and if it asserts that it has more than 12 creditors in its answer, it must comply with Rule 1003(b) and concurrently file the required creditor list.

The appellate court held that the bankruptcy court erred when it ruled on the numerosity motion to dismiss without requiring QDOS to answer and file its Rule 1003(b) list.

Moreover, the appellate court held that the bankruptcy court erred when it did not allow creditors a meaningful opportunity to join in the involuntary petition and by denying the petitioning creditors a reasonable opportunity for discovery so that they could solicit creditors to join. Binding Ninth Circuit precedent requires that all creditors have a reasonable opportunity to join in an involuntary petition. The bankruptcy court erred when it did not allow creditors a meaningful opportunity to join in and by denying the petitioning creditors a reasonable opportunity for discovery so that they could solicit creditors to join.

AUTHOR’S COMMENTS

The bankruptcy court held that a claim held by a creditor that is partially disputed is “the subject of a bona fide dispute as to liability or amount” thereby disqualifying the creditor from petitioning to commence an involuntary bankruptcy case under 11 U.S.C. § 303(b)(1).

Although the Bankruptcy Appellate Panel declined to address the issue, the Ninth Circuit in

Mont. Dep’t of Revenue v. Blixseth, 942 F.3d 1179 (9th Cir 2019), recently agreed with the bankruptcy court’s holding.

These materials were written by Everett L. Green, an attorney with the U.S. Department of Justice, Office of the United States Trustee, who is a member of the ad hoc group and a member of the Business Law Section’s Executive Committee. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), also a member of the ad hoc group. Thomas Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomas Reuters.