On the same day, the Ninth Circuit Bankruptcy Appellate Panel issued two opinions in the same case laying down important rules for involuntary petitions:

(1)  Fully secured creditors with nonrecourse claims are counted in deciding whether there are 12 or more creditors; and

(2)  If a creditor has a claim on the filing date, the creditor is counted even if the claim is paid off later.

Initially, the only creditor filing the involuntary chapter 7 petition had a judgment claim for more than $7 million. Later, several other creditors filed joinders in the involuntary petition. Ultimately, the bankruptcy judge decided that there were 12 creditors with claims that were “not contingent as to liability or the subject of a bona fide dispute as to liability or amount,” the standard in Section 303(b)(1) for deciding who may be an involuntary petitioner and how many involuntary petitioners there must be. If there were fewer than 12 creditors, one involuntary petitioner is enough under Section 303(b)(2).

One of the 12 creditors had a fully secured, nonrecourse claim. The creditor who first filed the involuntary petition therefore contended that the fully secured creditor should not be counted. Were that correct, there would be only 11 creditors, and one involuntary petitioner would be enough.

The bankruptcy judge decided that the fully secured creditor was counted and dismissed the involuntary petition. The petitioning creditor with the $7 million claim filed an appeal.

Fully Secured Creditors Are Counted

Writing the first of the BAP’s two decisions on October 29, Bankruptcy Judge William J. Lafferty, III, found no controlling authority to resolve the first question but said that “a majority of out-of-circuit decisions . . . hold that fully secured, nonrecourse creditors are countable creditors for purposes of § 303(b).”

The outcome turned on the interpretation of Section 303(b)(1). When there are 12 or more creditors, the subsection says that the involuntary petition must be filed

by three or more entities, each of which is either a holder of a claim against such person 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 [$18,600] more than the value of any lien on property of the debtor securing such claims held by the holders of such claims.

Judge Lafferty said that the subsection “does not explicitly differentiate between petitioning creditors and countable creditors; instead, the statute simply requires that both types of entities must qualify as ‘holders.’” He decided that “cases interpreting which entities are eligible as ‘holders’ under § 303(b) are as relevant to the eligibility of countable creditors as they are to the eligibility of petitioning creditors.”

Judge Lafferty said that the language in “§ 303(b) is explicit and specific about which entities qualify as countable creditors.” Although a fully secured creditor could not be the sole involuntary petitioner, he said that “§ 303(b) does not otherwise expressly prevent fully secured creditors from qualifying as either a petitioning creditor or a countable creditor.”

While a majority of courts “also support this interpretation,” Judge Lafferty scrutinized but rejected two opinions holding to the contrary, both from bankruptcy courts in Texas.

Judge Lafferty found support for his conclusion both from legislative history and policy considerations. He observed that fully secured creditors were not counted under the former Bankruptcy Act. He concluded that the omission from the Bankruptcy Code was “intentional” and provided further evidence supporting his holding.

Judge Lafferty identified several policy reasons supporting his conclusion. Affirming the bankruptcy court, he held that “fully secured creditors, whether recourse or nonrecourse, qualify as countable creditors under § 303(b).”

Paid Claims Are Still Counted

Judge Lafferty’s second opinion involved a creditor who was leasing a fence to the debtor for $45 a month. The creditor joined as an involuntary petitioner after the filing date but had a $45 claim on the filing date. Sometime after the filing date, a third party paid the $45 claim that existed on the filing date.

When the debtor was challenging the involuntary petition, the $45 creditor had unpaid claims that arose after filing. Later still, the $45 creditor sought to withdraw its joinder in the involuntary petition.

Relying largely on the word “holder” in Section 303(b)(1), the bankruptcy court decided that the $45 creditor could not be an involuntary petitioner because the claim that existed on the filing date had been paid. Judge Lafferty disagreed, although he said it was “a difficult question” and that he “could not find . . . any authorities directly addressing the issues raised in this appeal.”

Although the word “holder” was “relevant,” Judge Lafferty said that “other statutory provisions compel a different interpretation than the one reached by the bankruptcy court.”

Judge Lafferty cited Section 303(c), which says that creditors join as involuntary petitioners “with the same effect as if such joining creditor were a petitioning creditor under section (b) of this section.” He went on to explain why “the qualifications of petitioning creditors are assessed as of the petition date.”

Judge Lafferty did “not believe that postpetition satisfaction of a party’s claim necessarily renders that party a ‘noncreditor.’” He cited Section 101(10), which defines a “creditor” as an “entity that has a claim against the debtor that arose at the time of or before the order for relief concerning the debtor.” If an order for relief is entered, the court determines the allowance of the claim as of the date of filing.

Even if eligibility for being an involuntary creditor is not determined as of the filing date, Judge Lafferty noted that the creditor held a claim when it joined as a petitioner. Furthermore, as of the filing date, the creditor’s future claims were not “contingent.” Rather, they were “simply unmatured.”

“Because § 303(c) does not explicitly restrict creditors holding unmatured claims from joining a petition,” Judge Lafferty held, “a creditor owed a continuing obligation at the time it joins a petition presently holds a claim, even if a particular invoice is not due at the time the creditor files its joinder.” [Emphasis in original.]

Judge Lafferty reversed the bankruptcy court for failing to count the $45 creditor among the involuntary petitioners. However, he remanded for the bankruptcy court to consider whether the creditor could withdraw its joinder in the involuntary petition.

The opinions are Wolverine Endeavors VIII LLC v. East West Bank (In re King), 24-1007 and 24-1008 (B.A.P. 9th Cir. Oct. 29, 2024).