By: Donald L Swanson
Can a creditor’s future right to convert an existing debt claim to equity prevent that creditor from being an involuntary bankruptcy petitioner under § 303(b)?
- That’s the issue resolved in In re QDOS, Inc., Case No. 8:18-bk-11997, Central California Bankruptcy Court (decided July 23, 2024; Doc. 438).
The QDOS opinion involves a disputed involuntary bankruptcy petition. The dispute arises from the fact that two petitioning creditors hold debt claims against the debtor with future rights to convert each of those debt claims to equity.
11 U.S.C. § 303(b)(1) says in part (emphasis added):
- “An involuntary case against a person is commenced by the filing . . . of a petition . . . by three or more entities, each of which is . . . 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.”
So, the issue in the QDOS opinion is whether the creditors’ conversion-to-equity rights make their respective claims against Debtor, for § 303(b)(1) purposes, (i) post-petition claims, (ii) “contingent as to liability,” or (iii) “the subject of a bona fide dispute as to liability or amount”?
The Bankruptcy Court rules that the claims of both creditors are pre-petition, noncontingent, and undisputed; therefore, both claimants qualify as petitioning creditors under § 303(b)(1).
Here is a summary of the Bankruptcy Court’s analysis.
Pre-Petition Claim
The Court’s essential findings are:
- “It is undisputed that at the time of the filing of the involuntary petition, these two creditors . . . held debt against QDOS”; and
- “Debtor was legally obligated for those debts, whether they were due or not at the time.”
The Court adds: “It does not matter whether the debt is matured or unmatured at the time of the petition; it only matters that it was a ‘claim’ as defined under the Bankruptcy Code.”
–Definitions & Explanations
Then the Court offers this trail of definitions and explanations:
- a “‘claim’ in bankruptcy is defined as: (A) a right to payment, whether or not reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured”;
- “‘Debt’ is defined as a liability on a claim”; and
- claims “arise” for bankruptcy purposes, (i) when “all ‘transactions’ or acts necessary for liability occur,” (ii) “regardless of enforcement efforts (i.e., future litigation),” and (iii) regardless of “whether the claim is contingent, unliquidated, or unmatured when the petition is filed.”
–Irrelevance of Post-Petition Factors
The two creditors’ claims are still pre-petition claims, even if those claims can be changed to equity after the filing of the involuntary bankruptcy petition.
Post-petition factors cannot change a pre-petition claim into a post-petition claim:
- a payment becoming due after the bankruptcy filing “does not alter the conclusion that the payments are pre-petition obligations”;
- a claim “is not rendered a post-petition claim simply by the fact that time for payment is triggered by an event that happens after the filing of the petition”;
- “dependency on a post-petition event does not prevent a debt from arising prepetition”; and
- a claim is not transformed from pre-petition to post-petition “simply because it is contingent, unliquidated or unmatured when the debtor’s petition is filed.”
Not Contingent
Debtor argues that the debts in question (on the day before, or on the date of the petition filing) were contingent because:
- the holders of the debts claims had not converted those debt claims to equity.
Such argument “is a non-starter.” Here’s why:
- circumstances giving rise to the rights of a creditor to cancel their claim (even by conversion to equity) cannot be equated to the other types of contingencies appearing in case law;
- an example of a contingent claim is a debtor’s guarantee of an unmatured third party obligation—but the facts in this case are not even close to such a scenario;
- here, direct debts exist because (i) such debts might go away by conversion to equity later, but that option does not make the debt as of the petition date contingent, (ii) each creditor still has a claim at the involuntary petition filing, and (iii) Debtor still has a debt to each.
Moreover, the creditors’ signing and filing of the involuntary petition could be considered a prima facie rejection of the option to convert the debt to equity.
No Bona Fide Dispute
Under Debtor’s own arguments, there is no legitimate disagreement over whether the money is owed or how much.
The only dispute is whether the petitioning creditors can or will destroy their pre-petition claims by converting their debt to equity in the future. The two creditors still had non-contingent claims, not in bona fide dispute, on the date of the petition filing.
Procedurally, the Ninth Circuit says a bankruptcy court is not asked to evaluate the potential outcome of a claim disputed under § 303(b). Instead, the question is whether facts exist that raise a legitimate disagreement on whether money is owed or how much.
- No such facts exist in this case.
Creditors’ Unnecessary Arguments
Wanting to avoid an ineligible-creditor outcome, the two creditors make various other arguments:
- that they didn’t enter into such an agreement;
- that the agreement had somehow changed;
- that they entered into a different agreement; and
- that they are owed non-contingent, liquidated obligations under other agreements.
But such arguments are unnecessary, because of the findings and rulings above.
Conclusion
So, the Central California Bankruptcy Court declares and explains, in In re QDOS, Inc., that a creditor’s future right to convert its existing debt claim to equity does not prevent that creditor from being an involuntary petitioner under § 303(b)(1).
Very interesting!
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