An Issue That Has Confounded Courts Do Insiders Have Standing to File an Involuntary Petition in Small Cases

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Dec/Jan 2002

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Since the enactment of not only the Bankruptcy Code but also the Bankruptcy Act,
courts have struggled with the issue of whether, in cases involving 12 or less
creditors, an insider has standing to file an involuntary petition. Few contemporary
courts have addressed the issue in a published opinion. No consensus has emerged. This
article briefly examines the differing approaches to the issue.

<h3>Applicable Code Section</h3>

Section 303(b) of the Bankruptcy Code provides in relevant part:

<blockquote>
[a]n involuntary case against a person is commenced by the filing with the
bankruptcy court of a petition under chapter 7 or 11 of this title—

<blockquote>
(1) 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, or an indenture trustee representing such
a holder, if such claims aggregate at least $11,625 more than the
value of any lien on property of the debtor securing such claims held by
the holders of such claims;

(2) if there are fewer than 12 such holders, excluding any employee
or insider of such person and any transferee of a transfer that is
voidable under §544, 545, 547, 548, 549 or 724(a) of
this title, by one or more of such holders that hold in the aggregate
at least $11,625 of such claims.
</blockquote>
</blockquote>

11 U.S.C. §303(b).

Section 101(31) defines the term "insider"; the definition varies depending on
the status of the debtor. For instance, if the debtor is a corporation, insiders
include directors, officers and general partners of the debtor. See

§101(31)(B).

<h3>Courts Permitting an Involuntary Petition</h3>

A number of courts have interpreted §303(b) to allow an insider, or an
employee or transferee, with which insiders are associated in subpart (b)(2), to
file an involuntary petition in cases involving 12 or less creditors. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v.
Atwood (In re Atwood), 124 B.R. 402, 405 n.2 (S.D. Ga.
1991)</a> ("Petitioning creditors...qualify [to file an involuntary petition] even if
their claim is voidable."); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Little Bldgs. Inc., 49 B.R. 889,
890-91 (Bankr. N.D. Ohio 1985)</a> (denying debtor's motion to dismiss
involuntary petition filed by insiders); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re United Kitchen Assocs. Inc., 33
B.R. 214, 215 (Bankr. W.D. La. 1983)</a> ("Under the plain meaning
of 11 U.S.C. §303(b)(1) and (2), employees of the debtor may be
petitioning creditors for involuntary bankruptcy of the debtor.").

Of these courts, only the Little Bldgs. court actually reviewed the language of
the statute, and concomitantly, explained the basis for its decision. In denying a
motion to dismiss an involuntary petition filed by certain officers, directors, employees
or shareholders of the debtor, it found: "Although the [debtor] in this case has
argued that the language of the involuntary provisions should be interpreted to mean
that insiders must be excluded from the group of claimants eligible to file a
petition, the language of the section states, with mathematic-like certainty, that the
claims of insiders are excluded only from consideration in determining the number of
an alleged debtor's creditors." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Bldgs., 49 B.R. at 890-91</a>.
"Insiders are still eligible," it held, "to initiate involuntary proceedings against
the entity they are or were associated with." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 891</a>.

<h3>Courts Not Permitting an Involuntary Petition</h3>

A number of courts have reached the opposite conclusion: An insider, or employee
or transferee, lacks standing to file an involuntary petition in cases with fewer than
12 creditors. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Gills Creek Parkway Assocs. L.P., 194 B.R.
59, 62 (Bankr. D. S.C. 1995)</a> (asserting in dicta that claims of
employees, insiders and transferees of debtor are excluded from consideration in
determination of single creditor's eligibility to file involuntary petition); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Runaway II Inc., 168 B.R. 193, 198 (Bankr. W.D. Mo. 1994)</a>

(dismissing case filed by insider); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kenval Mktg. Corp., 38 B.R.
241, 244 (Bankr. E.D. Pa.) ("[C]reditors attempting to file
under...§303(b)(2)...are precluded from successfully filing if they hold
voidable preferences."), reconsideration denied, 40 B.R. 445 (Bankr. E.D.
Pa. 1984)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kreidler Import Corp., 4 B.R. 256, 259 (Bankr.
D. Md. 1980)</a> (rejecting "the construction advanced...that preferred creditors
are not counted but are eligible to join in an involuntary petition").

Because it contains an extended analysis of the plain meaning of the applicable
statute, Runaway is perhaps the most convincing authority for this proposition. The

Runaway court noted that the phrase "such holders" appears twice in §303(b)(2).
See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 168 B.R. at 196</a>. "The first use of 'such holders,'" it found,
"refers back to §303(b)(1) where a holder is 'a holder of a claim against such
person that is not contingent as to liability or the subject of a bona fide
dispute.'" <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; "However," it observed, "the first use of 'such holders' is
immediately followed by language excluding employees, insiders and creditors holding
avoidable transfers." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; The court found that "[t]hese exclusions modify the phrase
'such holders' as it is used in subsection (b)(2)." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; "The second use of
'such holders,'" it determined, "refers to the first use of the phrase in subsection
(b)(2) and its exclusions" and "directly modifies the 'one or more' creditor
language." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

"Thus," the court concluded, "to file a petition under (b)(2), a creditor must
hold a claim that is not contingent, subject to a bona fide dispute, nor be the
claim of an employee, insider or transferee of an avoidable transfer." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

In reaching this conclusion, the Runaway court disagreed with the Little Bldgs.
interpretation. It found that "the Little Bldgs. court looked only at the first use
of the term 'such holders' in subsection (b)(2)" and that "[i]t did not analyze
the second mention of the same term which appears after the exclusions." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

Further, the Runaway court noted that, under the Bankruptcy Act, "[courts] held
that creditor counting exclusions [now codified in §303(b)(2)] also affected the
creditor's standing to file or join an involuntary petition," <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 196-97</a>
(quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Nave-McCord Mercantile Co., 150 F. 71 (8th Cir.
1906)</a>). Finally, it asserted that "[t]he exclusion of insiders from filing a
petition makes sense from a policy perspective when, as here, the bankruptcy is the
result of an internal struggle for corporate control." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 198</a>.

The court concluded: "When there are less than 12 creditors, employees, insiders
and creditors receiving avoidable preferences cannot file an involuntary petition." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

<h3>Analysis</h3>

Plausible arguments can be raised in support of each approach. For instance,
parties opposing the filing of an involuntary petition, such as the debtors themselves,
can argue that, as noted in Runaway, the language of §303(b)(2) should be
interpreted to disqualify insiders in cases involving less than 12 creditors.
Moreover, these parties can cite cases in which courts construed the corresponding
Bankruptcy Act provision in the same fashion. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 150 F.
71</a>. Finally, these parties can emphasize the point, apparently not raised in any
published opinion, that §303(b) contains a specific subpart authorizing the filing
of an involuntary petition against a partnership by its general partners, i.e.,

insiders. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §303(b)(3)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C.
§101(31)(C)(i)</a> (defining general partner in debtor as insider where debtor
is partnership). They can argue that if it had intended to allow all insiders,
including corporate insiders, to file an involuntary petition, Congress could have
easily included language to that effect in §303.

In contrast, insiders can argue that, as noted in Little Bldgs., the
exclusionary language in §303(b)(2) should be interpreted to apply for counting
purposes only. Further, they can emphasize that a consensus hardly existed among
courts with respect to the issue of insiders' eligibility under the Act to file an
involuntary petition; in fact, some courts found insiders eligible. See, e.g.,
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. Co. v. Sacks (In re J.J.S. Co.), 445 F.2d 138, 139
(7th Cir. 1971)</a> ("While 11 U.S.C.A. §95(e)...excludes shareholders,
officers and directors in the computation of the number of creditors of a bankrupt for
the purposes of determining how many creditors must join in the petition, it does not
serve to disqualify an officer, director or shareholder as a petitioning creditor."),

citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Ogami, 123 F.2d 78, 80 (9th Cir. 1941)</a>.

Yet another argument, apparently not raised in any published opinion, may carry the
day. Transferees generally lack incentive to file an involuntary petition. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Syke Mktg. Corp., 11 B.R. 891, 897 (Bankr. E.D.N.Y. 1981)</a>
("[A] creditor who is being paid lacks an incentive to join [or file] an involuntary
proceeding because of the risk that a portion of his claim would be sought as a
preference by the trustee while the balance of his claim would be discharged in
bankruptcy."). Although one can contemplate situations in which they may have selfish
reasons to file an involuntary petition, e.g., cases such as Runaway involving an
internal struggle for control, insiders and employees generally also lack such incentive.

See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; ("Insiders who have become creditors of their businesses are deterred...from
joining in [or filing] an involuntary petition."). Given this lack of incentive, one
can argue that Congress could not possibly have intended that these parties should lack
standing to file an involuntary petition. Indeed, it is for this very reason—lack of
incentive—that these parties are excluded for counting purposes. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 897-98</a>
(observing that Congress sought to avoid "collusion between the insolvent debtor and
friendly creditors through which an involuntary petition might be defeated" and concluded,
as a result, that "[t]hose who would be deterred from joining the effort to petition
a debtor into bankruptcy...are not to be counted according to the dictates of
§303(b)(2)").

Journal Authors

Henry M. Karwowski

Journal Date

Sunday, December 1, 2002 - 12:00

Bankruptcy Rule

2002