United States: Numerosity Requirement For Filing Involuntary Bankruptcy Petition

Section 303 of the Bankruptcy Code provides creditors with a mechanism to force a recalcitrant debtor into bankruptcy through the filing of an involuntary petition for relief. Pursuant to this section, an involuntary bankruptcy case may be commenced only under Chapter 7 or 11 of the Bankruptcy Code, and may only be brought against a person otherwise qualified to file a voluntary petition. Where the purported debtor has fewer than 12 creditors, the involuntary petition need only be filed by a single creditor. However, where the purported debtor has 12 or more creditors, the involuntary petition must be filed by at least three creditors.

In certain situations, more than one creditor may attempt to file an involuntary petition on account of a single obligation. For example, several parties may hold a shared judgment against a single debtor, or may be joint benefN.Y. May 1, 2015), the U.S. Bankruptcy Court for the Eastern District of New York determined that four judgment creditors holding a single default judgment based upon an apparent oral contract constituted four separate creditors for purposes of Section 303(b)(1). In that case, an involuntary Chapter 7 petition was filed against debtor John Zapas by five of his creditors. Of the five petitioning creditors, four were individuals each holding a claim pursuant to a single pre-petition state court judgment against Zapas in the amount of $656,683 (the judgment creditors). The fifth held a separate pre-petition state court judgment against Zapas in the amount of $460,374.

In In re Zapas, 2015 Bankr. LEXIS 1487 (Bankr. E.D.N.Y. May 1, 2015), the U.S. Bankruptcy Court for the Eastern District of New York determined that four judgment creditors holding a single default judgment based upon an apparent oral contract constituted four separate creditors for purposes of Section 303(b)(1). In that case, an involuntary Chapter 7 petition was filed against debtor John Zapas by five of his creditors. Of the five petitioning creditors, four were individuals each holding a claim pursuant to a single pre-petition state court judgment against Zapas in the amount of $656,683 (the judgment creditors). The fifth held a separate pre-petition state court judgment against Zapas in the amount of $460,374.

Zapas sought to dismiss the involuntary petition on the ground that the petitioning creditors failed to satisfy the numerosity requirement. Zapas asserted that he had more than 12 creditors, and thus at least three separate creditors were required to file the involuntary petition against him. Zapas argued that because the judgment creditors really held only one claim among the four of them, the judgment creditors should only be counted as one petitioning creditor for purposes of Section 303(b)(1).

In order to determine whether the judgment creditors constituted one creditor or four, the court began with an examination of the plain language of Section 303 of the Bankruptcy Code: In order to qualify as a petitioning creditor under Section 303(b), a petitioning creditor must be an "entity" and must be the "holder of a claim." Bankruptcy Code Section 101(15) defines "entity" as, among other things, "a person, estate, trust or governmental unit." For purposes of this definition, a "person" includes an individual, partnership and corporation. Accordingly, because each of the judgment creditors was an individual, the court held that they each qualified as an "entity" within the meaning of the Bankruptcy Code.

Likewise, Bankruptcy Code Section 101(5) defines "claim" as "a right to a payment, whether or not such right is reduced to judgment," or "a right to an equitable remedy for breach of performance if such breach gives rise to a right to a payment." Looking to state law, the court determined that the judgment creditors each had an enforceable "right to payment" derived from the $656,683 pre-petition state court judgment. Therefore, the court held that, given the plain language of Section 303, the judgment creditors were entities holding claims against Zapas, and each was thus qualified to sign the involuntary petition against Zapas.

The court next considered Zapas' argument that the judgment creditors constituted a single petitioning creditor since they held one "unseparated" judgment. In support of this position, Zapas relied on several nonprecedential cases wherein multiple interest holders were treated as a single petitioning creditor. The court rejected Zapas' argument, finding the cases cited by Zapas to be unpersuasive and/or readily distinguishable.

For example, in In re McMeekin, 16 B.R. 805 (Bankr. D. Mass. 1982), a husband and wife were found to constitute a single petitioning creditor where they held a judgment based on a promissory note payable to them jointly. There, the judgment arose out of the debtor's obligation to pay the husband and wife fixed payments pursuant to a written promissory note. Despite the fact that the underlying obligations had been reduced to judgment, the McMeekin court looked at the underlying promissory note to determine the obligations of the debtor and the petitioning creditors. The McMeekin court relied on the applicable state Uniform Commercial Code (UCC) to conclude that a promissory note payable to two or more people was enforceable only by all of them. Accordingly, the McMeekin court held that because there was only one right to payment under state law, the husband and wife held only a single claim.

Similarly, in In re Atwood, 124 B.R. 402 (S.D. Ga. 1991), the bankruptcy court (in a decision affirmed by the district court) held that two petitioning creditors, as joint holders of a judgment, held one claim between them for purposes of commencing an involuntary petition under Section 303(b). There, two petitioning creditors sued the debtor on claims arising from a joint venture arrangement. The two petitioning creditors held a shared legal claim and one held a separate legal claim. The state court entered a judgment in their favor against the debtor, combining the amount of damages assessed for both legal claims in favor of both petitioning creditors. The Atwood court held that because the petitioning creditors held the judgment jointly, the judgment only placed one obligation on the debtor to pay both creditors and the creditors only had one "right to a payment." The Atwood court primarily relied on McMeekin, reasoning that the petitioning creditors' status as "co-holders of a judgment is similar to that of joint-payees on a promissory note."

The Zapas court disagreed with the rationale of Atwood, and refused to apply the New York state UCC by analogy to judgments not arising from rights under the New York UCC. The court noted that the New York UCC "is restricted to commercial paper and is designed to protect persons engaged in commercial transactions involving instruments for the payment of money." Because the New York UCC does not apply to court-ordered money judgments, and given that the Zapas parties' underlying contract was presumably oral (thus lacking any underlying negotiable or applicable non-negotiable instrument), the Zapas court concluded that the legal reasoning applied by the Atwood court was inappropriate. In addition, the court recognized that while the Zapas judgment listed the judgment creditors "in the conjunctive and did not provide that each would receive separate awards but rather issued an undivided judgment for $656,683.15, nothing under New York law … prevents each party from enforcing or executing on the judgment without the joinder of the others."

It is important to note what Zapas does not stand for: The proposition that a court will never look behind a shared judgment to determine whether a group of judgment holders should be considered a single petitioning creditor. To the contrary, the Zapas court noted that bankruptcy courts can—and often do—"look beyond pre-petition judgments to determine the nature of the underlying obligations." In making that point, the bankruptcy court hinted that it might very well have looked beyond the judgment to make a more reasoned determination of the nature of Zapas' obligation. However, because of the fact that the pre-petition judgment against Zapas was entered by default, the bankruptcy court had very little before it to make such a determination. In any event, the Zapas decision leaves open the possibility that multiple creditors holding a single judgment may be considered as separate creditors for purposes of Section 303(b)(1).

This article originally appeared in The Legal Intelligencer

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights. Jarret P. Hitchings is an associate in the firm's Wilmington, Delaware, office and practices in the area of business reorganization and financial restructuring.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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