FILED
NOV 7 2019
ORDERED PUBLISHED
SUSAN M. SPRAUL, CLERK
U.S. BKCY. APP. PANEL
OF THE NINTH CIRCUIT
UNITED STATES BANKRUPTCY APPELLATE PANEL
OF THE NINTH CIRCUIT
In re: BAP No. CC-18-1301-TaFS
QDOS, INC., Bk. No. 8:18-bk-11997-MW
Debtor.
MATTHEW HAYDEN; FELICE TERRIGNO; JIM
MADDOX; CARL WIESE, as trustee for the
Wiese Family Trust dated as of
October 31, 2013,
Appellants,
v. OPINION
QDOS, INC.,
Appellee.
Argued and Submitted on September 26, 2019
at Pasadena, California
Filed – November 7, 2019
Appeal from the United States Bankruptcy Court
for the Central District of California
Honorable Mark S. Wallace, Bankruptcy Judge, Presiding
Appearances: 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.
TAYLOR, Bankruptcy Judge:
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.
1
Unless specified otherwise, all chapter and section references are to the
Bankruptcy Code,
11 U.S.C. §§ 101–1532, all “Rule” references are to the Federal Rules
of Bankruptcy Procedure, and all “Civil Rule” references are to the Federal Rules of
Civil Procedure.
2
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.
FACTS
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
2
We exercise our discretion to take judicial notice of documents electronically
(continued...)
3
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.
2
(...continued)
filed in the bankruptcy case. See Atwood v. Chase Manhattan Mortg. Co. (In re Atwood),
293
B.R. 227, 233 n.9 (9th Cir. BAP 2003).
4
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
3
QDOS also argued that the Wiese Family Trust and Mr. Hayden were not
appropriate petitioning creditors because it disputed that payment on their claims was
required at the time of the involuntary petition. The bankruptcy court disagreed; it
preliminarily determined that because liability and the amount owed were not in
question, the Wiese Family Trust and Mr. Hayden qualified as petitioning creditors. But
(continued...)
5
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.
JURISDICTION
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).
ISSUE
Did the bankruptcy court err when it dismissed the involuntary
petition?
STANDARD OF REVIEW
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
3
(...continued)
it also allowed for additional briefing. QDOS filed a document that agreed with the
bankruptcy court’s analysis but raised another issue; it argued that because these
entities had the right to convert their claims to stock, they were contingent creditors
and, thus, disqualified as petitioning creditors. The bankruptcy court has not decided
this issue, and QDOS does not advance arguments related to the qualifications of the
Wiese Family Trust and Mr. Hayden on appeal. Because resolution of this issue is
irrelevant given the basis of our decision, we do not further consider this point.
6
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).
DISCUSSION
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
7
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
4
Financial distress also may be demonstrated where, within the 120 days
previous, a custodian was appointed for substantially all of the debtor’s assets.
11
U.S.C. § 303(h)(2). No one argues that this section applies here.
8
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 creditors and also disputed
5
QDOS’s request for abstention as an alternative to dismissal of the involuntary
petition evidences its fundamental misunderstanding of the purpose of a proper
involuntary petition. It argued that because state court litigation was pending in
connection with the initial Petitioning Creditors’ claims, the involuntary bankruptcy
was unnecessary and improper. But an involuntary filing does not necessarily remove
the litigation from state court; the bankruptcy court may elect to allow the claim to be
liquidated there. Instead, an involuntary case can help to achieve appropriate
bankruptcy purposes. Reorganization or orderly liquidation may follow.
9
that it was in economic distress.
277 F.3d at 1065, 1070–71. So, pending trial
on both disputed issues, the bankruptcy court ordered it to submit a list of
its creditors to the bankruptcy court, and the parties agreed that the list
could not be released without a court order.
Id. at 1070. The petitioning
creditors did not ask for pre-trial release of the list.
Id. At trial, the
bankruptcy court found that the number of then-existing petitioning
creditors was insufficient, but it also continued with the trial and
determined that Vortex Fishing was generally paying its debts as they
came due.
Id. at 1063. It then dismissed the involuntary petition.
Id.
On appeal, the petitioning creditors argued, based on Rule 1003(b),
that the bankruptcy court should have notified all creditors of the
involuntary petition, afforded them an opportunity to join, and only then
dismissed the involuntary case.
Id. at 1070. The Ninth Circuit rejected this
argument.
It noted that generally when an alleged debtor answers a petition
filed by fewer than three qualifying petitioners, asserts the § 303(b)(1)
three-petitioning creditors requirement, and alleges that it has twelve or
more creditors, the bankruptcy court “must assure that other creditors have
a ‘reasonable opportunity’ to exercise their § 303(c) statutory power to join
as petitioners . . . .” Id. at 1071. But the Ninth Circuit concluded:
We cannot say, in the face of Rule 1013(a) and of the omission
of the appellants to ask that the creditor list be released, that the
Bankruptcy Court abused its discretion when it proceeded to
10
determine the merits of the contested involuntary petition—i.e.
whether Vortex was generally paying its debts as they came
due—without requiring specific notification of other creditors.
Id. at 1071–72.
Vortex Fishing, thus, underscores that all creditors must have a
reasonable opportunity to join in an involuntary petition.6 It was unnecessary
there only because, in a consolidated hearing, the bankruptcy court
correctly found that the involuntary debtor was not in financial distress;
joinder, thus, would have been a meaningless endeavor.
The decisional process in relation to a contested involuntary
petition must be prompt but also consistent with Rule 1018 and the Civil
Rules it incorporates. While the standards for allowance of an involuntary
petition are clear, the procedure for making a qualification determination is
more meandering.
6
To that extent, § 303(j) and Rule 1017 are enlightening. Section 303(j) governs
dismissal of an involuntary petition and requires notice to all creditors when dismissal
follows petitioner motion, or petitioner and debtor consent, or is based on want of
prosecution.
11 U.S.C. § 303(j). Rule 1017 provides that such dismissal cannot occur
before a hearing and notice to all creditors pursuant to a list provided by the debtor or
other knowledgeable entity. Fed. R. Bankr. P. 1017(a). The First Circuit BAP concluded
in an unpublished decision that “Rule 1017 applies in the context of a motion to dismiss
an involuntary petition for failure to obtain the requisite number of petitioning
creditors.” Banco Popular de Puerto Rico v. Colon (In re Colon), BAP No. PR 07-053,
2008
WL 8664760, at *7 (1st Cir. BAP Nov. 21, 2008). As a result, § 303(j) and Rule 1017
supported its conclusion that a bankruptcy court erred when it dismissed an
involuntary petition on an insufficient number of creditor’s ground without “at least
giving all creditors notice and the opportunity for a hearing.” Id. at *8.
11
An involuntary debtor may initially contest the involuntary
petition through a Civil Rule 12(b)(6) motion, but where a trial is
required for resolution it must answer and file the list required by Rule
1003(b). Rule 1011 provides that the debtor may contest an involuntary
petition, and it expressly allows the alleged involuntary debtor to file a
Civil Rule 12 motion before answering. Fed. R. Bankr. P. 1011(a), (b), and
(c). Thus, Civil Rule 12(b)(6) applies in a contested involuntary situation
just as it does generally; the motion challenges the sufficiency of the
allegations in the involuntary petition and “may be based on either a ‘lack
of a cognizable legal theory’ or ‘the absence of sufficient facts alleged under
a cognizable legal theory.’ ” Johnson v. Riverside Healthcare Sys.,
534 F.3d
1116, 1121 (9th Cir. 2008) (citation omitted). The court accepts factual
allegations as true but disregards legal conclusions. Ashcroft v. Iqbal,
556
U.S. 662, 678–79 (2009). It then determines if the remaining factual
allegations, construed in the light most favorable to the non-moving party’s
favor, state a facially plausible claim for relief.
Id. at 679; see also Bell Atl.
Corp. v. Twombly,
550 U.S. 544 (2007).
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
12
the involuntary debtor must answer.7
When an involuntary debtor files a Civil Rule 12(b)(6) motion in
connection with a contested involuntary bankruptcy, Rule 1011 extends the
time for the answer as permitted in Civil Rule 12(a). Fed. R. Bankr.
P. 1011(c). Civil Rule 12(a) provides that where a court denies a Civil
Rule 12(b) motion or postpones its determination until trial, the answer
must be filed within 14 days of the court’s action. Fed. R. Civ.
P. 12(a)(4)(A). So, once a trial is required to resolve issues in a contested
involuntary proceeding, the involuntary debtor must answer within 14
days.
And, if the debtor 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. Fed. R. Bankr. P. 1003(b). Rule 1003(b) serves two
purposes. It implements, in part, § 303(c)’s joinder provisions. In re Vortex
Fishing Sys., Inc.,
277 F.3d at 1071. And it provides the mechanism by which
an alleged debtor substantiates its assertion that it has more than
12 qualifying creditors and returns the burden to petitioning creditors. In re
Clignett,
567 B.R. 583, 587 (Bankr. C.D. Cal. 2017) (“[A] debtor cannot
merely state that [it] has more than twelve creditors in [its] motion to
7
Rule 1018 also allows for summary judgment. But just as in ordinary civil
litigation, the court may not grant summary judgment if genuine disputes of material
fact exist or further discovery is warranted.
13
dismiss.”).
In summary, if resolution of a contested involuntary proceeding
requires a trial, there is no procedural path that allows the alleged
involuntary debtor to leap over the requirement that it answer and, if
appropriate given its answer, file the creditor list mandated by Rule
1003(b). The mere fact that the involuntary debtor initiated its opposition
through a Civil Rule 12(b)(6) motion delays, but does not invariably negate,
the requirement of answer and creditor list.
The requirement that contested involuntary petitions be resolved
quickly must be read in tandem with the fact that Civil Rule 26 governs
the pre-trial process and that discovery is available under Civil Rules
7028 through 7037. Rule 1013(a) directs bankruptcy courts to “determine
the issues of a contested petition at the earliest practicable time and
forthwith enter an order for relief, dismiss the petition, or enter any other
appropriate order.” Fed. R. Bankr. P. 1013(a). The “earliest practicable
time” is when the bankruptcy court has “sufficient information to resolve
the conflict” before it. Hayes v. Rewald (In re Bishop, Baldwin, Rewald,
Dillingham & Wong, Inc.),
779 F.2d 471, 475 (9th Cir. 1985). Often the
bankruptcy court will acquire this information at trial.
Where trial is required to adjudicate an involuntary petition,
Rule 1018 incorporates many procedural Rules and expressly provides that
references to adversary proceeding therein include a reference to a
14
proceeding to contest an involuntary petition. Fed. R. Bankr. P. 1018.
Several of the incorporated rules are critical to providing the parties with
the information they need to either contest or defend the involuntary
petition at trial.
First, Rule 1018 incorporates Rule 7026 which makes the
requirements of Civil Rule 26 applicable.
Id. The initial notice requirements
of Civil Rule 26 mandate pre-discovery disclosure of individuals likely to
have relevant discoverable information and production of documents
supporting claims or defenses. Fed. R. Civ. P. 26(a)(1)(A)(i) & (ii).
Rule 1003(b) works in tandem with this requirement and, because it
mandates the creditor list when the involuntary debtor answers, actually
accelerates disclosure on this topic. But, even if Rule 1003(b) did not require
early submission of the creditor list, there can be no doubt that a list of
creditors or the provision of documents containing creditor information
would be a required Civil Rule 26(a)(1)(A) disclosure where there is a
dispute regarding the number of creditors.
Civil Rule 26 also affects the pace of resolution unless the bankruptcy
court is immediately proactive. Rule 1018 allows for all typical discovery as
it incorporates Civil Rules 7028 through 7037. Fed. R. Bankr. P. 1018. But
such discovery cannot proceed until the parties confer as required by Civil
Rule 26(f) or as otherwise agreed by the parties or ordered by the
bankruptcy court. Fed. R. Civ. P. 26(d)(1). To achieve the prompt resolution
15
required by Rule 1013(a), the bankruptcy court may establish a discovery
schedule that removes the limitations imposed by Civil Rule 26(d)(1).
In short, Rule 1018 makes clear that resolution of a contested
involuntary petition should proceed with the discovery and disclosures
typical in an adversary proceeding, but Rule 1013(a) mandates that the
process move speedily.
B. The bankruptcy court erred when it imposed § 303(b)(1)’s
numerosity requirement, did not require an answer, failed to
allow for appropriate discovery, and dismissed the case
before allowing appropriate notice and a meaningful
opportunity for joinder to all creditors.
As noted, a Civil Rule 12(b)(6) motion assumes the truth of the
allegations in the operative documents, here the involuntary petition. And
the involuntary petition in this case does not allege that QDOS had 12 or
more qualifying creditors. As a result, § 303(b)(1) does not facially apply
and there only needed to be at least one qualifying petitioning creditor. The
bankruptcy court correctly recognized that it could not resolve the issues
without a trial.
The bankruptcy court, thus, accepted matters extrinsic to the
pleadings.8 In support of its assertion that it had more than 12 creditors,
8
The bankruptcy court stated at one point that it was converting the proceeding
to a summary judgment, but we read this as shorthand. The bankruptcy court correctly
determined that triable issues existed; thus, trial was required, and summary
adjudication was impossible.
16
QDOS submitted Richard Gillam’s, QDOS’s CEO, declaration, which
baldly stated: “QDOS, Inc. has twelve or more entities or individuals which
would be classified as claimholders pursuant to
11 U.S.C. §§ 101(5), 303.”
At no time did QDOS provide additional information about its creditors.
Petitioning Creditors argued to the bankruptcy court and on appeal that
this generic statement is insufficient. We agree.
The bankruptcy court erred when it proceeded to trial without
requiring QDOS to answer and file its Rule 1003(b) list. When Petitioning
Creditors asked the bankruptcy court to enforce the Rule 1003(b)
requirement, it declined to do so because, it reasoned, Rule 1003(b) applies
to answers, not motions to dismiss. This reliance was misplaced.
We acknowledge that some courts find a “gap” in the Rules related to
Rule 1003(b). In re Kidwell,
158 B.R. at 209. Put simply, an alleged debtor is
allowed to raise the defense of a failure to comply with the three-petitioner
requirement by either a motion to dismiss under Civil Rule 12 or by an
answer, but Rule 1003(b) only facially applies when the defense is raised by
answer, not motion.
Id. The “sensible solution”, concluded Kidwell, is to
apply the same procedure when the defense is raised by motion.
Id. at 210.
If there is a gap, we completely agree with Kidwell.
But if Rule 1011 is read in full and one recognizes that Rule 1018
treats contested involuntary petitions as adversary proceedings, there is no
gap. Rule 1011 allows the filing of a Civil Rule 12 motion, but Rule 1018
17
incorporates Civil Rule 8 and requires the assertion of defenses through an
answer when Civil Rule 12(b)(6) relief is not available. And Rule 1011(c)
states that filing a Civil Rule 12 motion extends the time for filing a
responsive pleading or answer. Finally, Civil Rule 12(a)(4)(A) provides that
the answer is due 14 days after the court denies a Civil Rule 12(b)(6)
motion or postpones disposition until after trial.
So here, once the bankruptcy court implicitly denied QDOS’s Civil
Rule 12(b)(6) motion and actually postponed decision until trial, QDOS
was required to answer within 14 days and to accompany its answer with
the list required by Rule 1003(b) as it asserted that it had more than 12
creditors.9
The bankruptcy court erred when it proceeded to trial and
dismissed the involuntary petition without allowing Petitioning
Creditors a reasonable opportunity for discovery. The bankruptcy court
denied Petitioning Creditors any reasonable opportunity for discovery.
First, discovery is generally inappropriate while a Civil Rule 12(b)(6)
motion is pending. At some point, Petitioning Creditors informally
9
And, again, QDOS was also required to provide Civil Rule 26(a)(1) initial
disclosures even before receiving a discovery request. As these disclosures require the
name and contact information for all parties with discoverable information and
identification of all documents supporting all claims—here that more than 12 creditors
existed—it is impossible to assume that QDOS’s compliance with these rules would not
have identified its creditors before trial if QDOS acted as required by Rule 1018. Fed. R.
Civ. P. 26(a)(1)(A)(i)–(ii).
18
attempted to confer with QDOS to obtain discovery; this conferral is
required by Civil Rule 26(d)(1). QDOS was not cooperative. But the
bankruptcy court penalized the Petitioning Creditors—it erroneously
asserted that discovery should have commenced before it took any action
on the pending Civil Rule 12(b)(6) motion, and it declined a request for a
telephonic discovery conference six business days after it set the matter for
trial. The bankruptcy court never relieved the parties from the
requirements of Civil Rule 26(d)(1) or otherwise regulated discovery. And
it limited the time for joinder in the petition to three weeks following its
implicit denial of the motion to dismiss and its conclusion that a trial was
necessary. The Petitioning Creditors could not obtain discovery allowing
them to solicit joinders before the deadline for joinder passed unless the
bankruptcy court shortened time; but it declined their requests for
assistance in obtaining discovery.
We also acknowledge that in some regards the errors in relation to
discovery may be harmless. The Petitioning Creditors dispute that QDOS
has more than 12 creditors, but we have evidence in the record of 11
creditors exclusive of Mr. Terrigno and Mr. Maddox.10 It seems likely that
more exist. And QDOS should have provided the critical information as to
10
Five creditors other than the Petitioning Creditors filed proofs of claim, and the
Petitioning Creditors requested judicial notice of another four recent judgments against
QDOS.
19
the identity of creditors with the required answer or as an initial disclosure.
Here the failure to allow discovery as allowed and conditioned by Rule
1018 merely compounded an existing problem. Petitioning Creditors could
not remedy these defects through the discovery allowed by Rule 1018.
We acknowledge that the bankruptcy court correctly emphasized
Rule 1013(a)’s requirement that bankruptcy courts decide the merits of a
contested petition at the earliest practicable time. But Rule 1013(a) must be
read in concert with Rule 1018. Rule 1013(a)’s expeditious trial requirement
cannot negate Rule 1018 on the grounds that there is no time for discovery.
The bankruptcy court erred when it did not allow all creditors a
meaningful opportunity to join in the involuntary petition. In this case,
the bankruptcy court did not provide for reasonable notice to all of QDOS’s
creditors and, thus, it denied them their statutory right to join in the
involuntary petition. The bankruptcy court intimated, at one point, that
other creditors had a “reasonable opportunity” to join because the petition
had been pending for more than five weeks on a public docket. The mere
pendency of a bankruptcy petition, however, is not sufficient notice to
creditors. In re Vortex Fishing Sys., Inc.,
277 F.3d at 1071 (“[Rule 1003(b)],
which functions to provide an opportunity to moot a defense of
insufficiency in the number of petitioners, is needed because all creditors
do not necessarily receive notice of an involuntary case until there is an
order for relief adjudicating the merits of the petition in favor of the
20
petitioning creditors.”).
And while the bankruptcy court allowed Petitioning Creditors a
limited opportunity to solicit additional creditors after it set the matter for
hearing,11 Petitioning Creditors had no list of creditors to solicit. Again,
they had no Rule 1003(b) list, no initial disclosures, and no reasonable
opportunity to conduct discovery. As a result, we conclude that the
bankruptcy court erred when it dismissed the involuntary petition based
on a § 303(b)(1) infirmity without affording other creditors an opportunity
to join the involuntary petition through Rule 1003(b) notice or Petitioning
Creditor solicitation.
Vortex Fishing Systems, Inc. does not stand for a contrary result. First,
the alleged debtor filed a sealed list of creditors but the petitioning
creditors never sought access to it and only raised Rule 1003(b) on appeal.
Here, Petitioning Creditors have consistently sought access to a list of
creditors or discovery on this topic. Second, the Vortex Fishing bankruptcy
court determined the merits of the contested petition and concluded that
Vortex Fishing was paying its debts as they came due. And the Ninth
Circuit affirmed that finding. As a result, it was immaterial whether there
was a sufficient number of petitioning creditors because, even if there were,
11
The temporal limitation on the time for joinder (three additional weeks) also
raises an issue. By statute, creditors can join an involuntary petition at any time before
“the case is dismissed or relief is ordered.”
11 U.S.C. § 303(c).
21
entry of an order for relief would have been inappropriate.
11 U.S.C.
§ 303(h)(1). Here, the bankruptcy court made no findings about whether
QDOS was paying its debts as they came due; QDOS effectively admitted
that it was not.12 Thus, it deprived creditors of the joinder right mandated
by Vortex Fishing.
The only creditor information that Petitioning Creditors had as to the
QDOS creditor body came from a declaration that came too late for
solicitation and named no one, trial testimony that asserted that it had 40 to
50 creditors but did not name them, and information obtainable from the
claims docket and litigation databases showing judgments against QDOS.
Both Rule 1003(b) and Ninth Circuit authority require more, especially
given that QDOS never argued that it was paying its undisputed debts as
they came due.
12
QDOS never disputed this point in its Civil Rule 12(b)(6) motion and when
questioned on appeal side-stepped inquiry by saying that other creditors were working
with it. Petitioning Creditors allege financial distress, and the claims docket in the
involuntary case supports this conclusion. A few creditors found the case and filed
claims; almost all evidence that QDOS was not regularly paying its debts. The IRS and
Employment Development Department filed substantial claims for unpaid and
delinquent tax obligations; these claims evidenced interest accruals, penalties, and tax
liens. In the EDD’s case, they alarmingly were filed on account of unpaid employee
withholdings. Another claim evidenced a judgment and lien from 2017. AT&T filed a
claim that evidenced arrearages, including some more than 90 days past due. And even
more dispositive of a broad-based failure to pay debts as they come due and financial
distress is a February 22, 2018 email from the QDOS principal that is attached to the
Wiese Family Trust proof of claim. See Claim No. 6 at 13–15. The Petitioning Creditors
also requested judicial notice of several recent judgments against QDOS.
22
C. The bankruptcy court did not err in concluding that
Mr. Maddox was not entitled to be a petitioning creditor at
that time.
The bankruptcy court concluded that Mr. Terrigno and Mr. Maddox
did not qualify as petitioning creditors. On appeal, Petitioning Creditors
only discuss Mr. Maddox’s disqualification.
To be a petitioning creditor, an entity must hold a claim that is not
contingent “as to liability or the subject of a bona fide dispute as to liability
or amount . . . .”
11 U.S.C. § 303(b)(1). The bankruptcy court concluded that
Mr. Maddox did not qualify as a petitioning creditor for two reasons: his
claim was subject to a bona fide dispute as to the amount of the claim, and
he did not appear in person at the trial. We start, and end, with the latter.13
13
The former reason is an unsettled area of law. Pre-BAPCPA, the Ninth Circuit
had held that the undisputed portion of a debt could qualify under § 303(b)(1) as not
subject to a bona fide dispute. Focus Media, Inc. v. Nat’l Broad. Co. (In re Focus Media,
Inc.),
378 F.3d 916, 926 (9th Cir. 2004). But in 2005 Congress amended § 303 and added
the phrase “as to liability or amount” after “bona fide dispute.” In re Honolulu Affordable
Hous. Partners, LLC, No. 15-00146,
2015 WL 2203473, at *2 (Bankr. D. Haw. May 7, 2015)
(Faris, J.). Some courts have found that the 2005 amendments overruled the Ninth
Circuit’s decisions. E.g., id.; see Mont. Dep't of Revenue v. Blixseth,
581 B.R. 882, 898 (D.
Nev. 2017) (citing cases). Two circuit courts have agreed with this line of reasoning.
Mont. Dep’t of Revenue, 581 B.R. at 898-89. But other bankruptcy courts (and Collier) have
concluded otherwise. Id. at 899–900; 2 Collier on Bankruptcy ¶ 303.11[2] (Richard Levin
& Henry J. Sommer eds. 16th ed. 2019).
Although neither we nor the Ninth Circuit have decided the matter, the Ninth
Circuit heard oral argument on this issue and took the matter under submission on
August 26, 2019. See Mont. Dep’t of Revnue v. Blixseth, Case No. 18-15064, Dkt. No. 47
(continued...)
23
Petitioning Creditors raise a variety of arguments on appeal. But,
crucially, they conceded at oral argument that the record contains no
explanation for Mr. Maddox’s failure to appear. He just did not show up.
The bankruptcy court had the right to control the proceedings before
it. QDOS disputed that Mr. Maddox properly qualified as a petitioning
creditor; it had the right to cross-examine him. And, the bankruptcy court’s
amended scheduling order was clear about the consequences for non-
appearance: the bankruptcy court would strike any and all declarations
signed by that petitioning creditor. At issue, in the main, was whether
Mr. Maddox held an undisputed claim. And the dispute centered on
whether his loan was usurious. We acknowledge that Mr. Maddox filed a
proof of claim that temporarily, and far from definitively, waived disputed
interest. But the bankruptcy court and QDOS had every right to question
him on this point. Thus, the bankruptcy court concluded that Mr. Maddox
had not carried his burden of proof that he was a qualifying petitioning
creditor. The bankruptcy court did not err in so deciding.14
(...continued)
(submitting appeal after oral argument on August 26, 2019). Because the bankruptcy
court excluded Mr. Maddox’s claim for an alternate reason, and we affirm on that
ground, we need not resolve this well-ventilated question.
14
We leave to the bankruptcy court’s discretion, on remand, whether
Mr. Maddox may revive his participation in the involuntary proceedings by, for
instance, appearing at future hearings to testify or by affirmatively and absolutely
(continued...)
24
CONCLUSION
Based on the foregoing, we REVERSE and REMAND for further
proceedings.
(...continued)
waiving the disputed portions of his claim. See 2 Collier on Bankruptcy ¶ 303.11[2] (“Of
course, as a practical matter, the prudent creditor will take the suggestion loudly
whispered by some courts and simply assert the undisputed, non-contingent portion of
its claim.” (footnotes omitted)). Unless, of course, in the interim, the Ninth Circuit
determines that he need not do so.
25
