Hayden v. QDOS, Inc. (In re Qdos, Inc.)
| Decision Date | 07 November 2019 |
| Docket Number | BAP No. CC-18-1301-TaFS,Bk. No. 8:18-bk-11997-MW |
| Citation | 607 B.R. 338 |
| Parties | IN RE: QDOS, INC., Debtor. Matthew Hayden; Felice Terrigno; Jim Maddox ; Carl Wiese, as Trustee for the Wiese Family Trust Dated as of October 31, 2013, Appellants, v. QDOS, Inc., Appellee. |
| Court | U.S. Bankruptcy Appellate Panel, Ninth Circuit |
Patrick Costello of Vectis Law Group argued for appellants;
Damian Capozzola of The Law Offices of Damian D. Capozzola argued for appellee.
Before: Taylor, Faris, and Spraker, Bankruptcy Judges.
INTRODUCTION
Matthew Hayden, Felice Terrigno, Jim Maddox, and the Wiese Family Trust ("Petitioning Creditors") sought to place QDOS, Inc. ("QDOS") into an involuntary chapter 11 proceeding.1 QDOS sought dismissal through a Civil Rule 12(b)(6) motion based on the assertion that none of the Petitioning Creditors were qualified to file the involuntary petition and, thus, the numerosity requirement of 11 U.S.C. § 303(b) was not met. The bankruptcy court recognized that the issue could not be resolved through a dismissal motion or other summary adjudication and held a trial. And because it determined that Mr. Terrigno was an investor, not a creditor, and because Mr. Maddox failed to appear, it agreed with QDOS and dismissed the petition.
Petitioning Creditors appeal. They do not dispute the disqualification of Mr. Terrigno. Nor do they adequately dispute the bankruptcy court's conclusion that Mr. Maddox failed to satisfy his burden of proof that he qualified as a petitioning creditor. All that said, we conclude that the bankruptcy court erred.
Under controlling Ninth Circuit law and the facts of this case, all creditors had the right to consider whether to join in the involuntary petition. But the bankruptcy court did not require QDOS to file an answer and the list of creditors required by Rule 1003(b) once it determined that triable issues existed. And it neither required Civil Rule 26 disclosures nor permitted discovery that would have otherwise allowed the Petitioning Creditors to give the required notice to creditors. The record reflects that QDOS's alleged 40 to 50 creditors had no reasonable opportunity to join in the involuntary petition. Dismissal based solely on an insufficiency in the number of petitioning creditors, thus, was error.
Therefore, we REVERSE and REMAND for further proceedings.
In May 2018, Carl Wiese (as trustee of the Wiese Family Trust dated as of October 31, 2013), Matthew Hayden, and Felice Terrigno filed an involuntary chapter 11 petition against QDOS.2 On the petition, they stated that each of their claims was for a loan.
QDOS moved to dismiss and requested § 303(i) damages; in the alternative, it sought abstention under § 305. It did not dispute the petition's allegation that it was not paying its debts as they came due; it focused solely on Mr. Terrigno and alleged that he did not hold a qualifying claim because he was an investor. It asserted that it had 12 or more claimholders, and, thus, the involuntary petition was not filed by three creditors as required by § 303(b).
Petitioning creditors opposed the motion. Among other things, they argued that the grounds for dismissal relied on disputed facts which could not be resolved on a Civil Rule 12(b)(6) motion to dismiss.
Two days before the hearing, the bankruptcy court issued a tentative ruling granting the motion because Mr. Terrigno was not a qualifying petitioner and, as a result, there were less than three qualifying petitioning creditors. It concluded that a Rule 1003(b) list was unnecessary because QDOS filed a motion instead of an answer.
But then Mr. Maddox joined the involuntary petition; the bankruptcy court set a trial for two days later and directed each petitioning creditor to appear personally or risk removal from the list of petitioning creditors.
The next day, Petitioning Creditors' counsel filed a document stating that they were unable to appear on less than 48 hours notice for a variety of reasons. So, the bankruptcy court continued the trial. Its order limited the time for additional joinders to the petition to the following three weeks.
Six business days later, Petitioning Creditors filed an ex parte request for a telephonic conference on discovery matters because QDOS was unwilling to negotiate a workable document production schedule and refused to file a Rule 1003(b) list. QDOS opposed the ex parte request, and the bankruptcy court thereafter entered an order striking it.
An additional delay in the hearing occurred. And the bankruptcy court altered the consequences of a failure to appear at the hearing from being struck from the list of petitioning creditors to the striking of the non-appearing petitioning creditor's declaration.
At the eventual trial, Mr. Maddox did not appear.
The bankruptcy court then entered a combined memorandum decision and order. It found that QDOS had more than 12 creditors for § 303(b)(1) purposes. It concluded that Mr. Terrigno was not a qualifying petitioning creditor because he was an equity holder.3 Next, it concluded that Mr. Maddox was not a qualifying petitioning creditor for two reasons: first, his claim was subject to a partial bona fide dispute; and second, he failed to appear at the hearing as ordered and, as a result, failed to meet his burden of proof that he was a qualifying petitioning creditor.
Petitioning Creditors timely appealed.
The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 and 157(b)(2)(A). We have jurisdiction under 28 U.S.C. § 158(a)(3).
Did the bankruptcy court err when it dismissed the involuntary petition?
We review de novo whether a particular procedure satisfies due process. Owens-Corning Fiberglass Corp. v. Ctr. Wholesale, Inc. (In re Ctr. Wholesale, Inc.) , 759 F.2d 1440, 1445 (9th Cir. 1985) ; Garner v. Shier (In re Garner) , 246 B.R. 617, 619 (9th Cir. BAP 2000).
We review the bankruptcy court's conclusions of law de novo and its conclusions of fact for clear error. Liberty Tool, & Mfg. v. Vortex Fishing Sys., Inc. (In re Vortex Fishing Sys., Inc.) , 277 F.3d 1057, 1064 (9th Cir. 2002).
The Code overhauled the standards for involuntary bankruptcy as they existed under the former Bankruptcy Act of 1898; it relaxed them and allowed an involuntary bankruptcy at an earlier point in an entity's economic decline. In re Kidwell , 158 B.R. 203, 212–13 (Bankr. E.D. Cal. 1993). At the same time, it allowed for monetary remedies that counterbalanced this new liberality. Id. at 213. The Rules then established the procedures that a bankruptcy court must follow in balancing the important concerns extant when a party seeks the involuntary bankruptcy of an unwilling debtor. In sum, they require a speedy resolution and a full complement of due process.
A. The law governing involuntary petitions.
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.
The Code requires that the involuntary debtor be in financial distress and that a sufficient number of undisputed creditors request involuntary relief. 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).4 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).
Joinder can remedy a deficiency in the number of petitioning creditors; and all creditors have the right to consider joinder where the involuntary debtor is in economic distress. Where there are fewer than the three required petitioning creditors, the Code and Rules allow for Civil Rule 24(a)(1) joinder. 11 U.S.C. § 303(c) ; Fed. R. Bankr. P. 1018. Thus, joinder may remedy a defect in the number of petitioning creditors.
In deciding the issue before it, whether joinder could cure even a tainted initial petition, the Kidwell court emphasized that such joinder was a matter of right. 158 B.R. at 211. It further noted the importance of the right to join given that an involuntary petition may provide significant benefit to all creditors. See id. at 212. We agree; where an entity is in true economic distress, an involuntary filing may stop the race to the state courthouse and the dismemberment of a debtor through involuntary liens, level the playing field among unsecured creditors, and otherwise appropriately aid creditors.5 Thus, the Kidwell court found that it is not permissible to deprive eligible creditors of their statutory right to join in the petition and then to dismiss for insufficiency in number of petitioners, even if an initial petitioning creditor misbehaved. Id. at 220.
The Kidwell court made a compelling case for a requirement that all claimholders receive an opportunity to consider supporting an involuntary petition when the debtor is in financial distress even if there initially are too few petitioning creditors. And in Vortex Fishing Systems , the Ninth Circuit agreed.
Vortex Fishing objected to an involuntary petition; it disputed the sufficiency in number of qualified petitioning...
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