IN RE: QDOS (2021)

MEMORANDUM DECISION AND ORDER GRANTING IN PART AND DENYING IN PART QDOS, INC.'S MOTION FOR SUMMARY JUDGMENT

Creditors Matthew Hayden (“Mr. Hayden”) and Carl Wiese, as trustee for the Wiese Family Trust u/t/a dated October 31, 2013 (“Mr. Wiese”) filed an involuntary chapter 11 petition against QDOS, Inc. (“QDOS”) on May 31, 2018. The issue whether Messrs. Hayden and Wiese and those who joined with them as petitioning creditors qualify as such under the Bankruptcy Code has been hotly disputed over many months. This Court has not yet entered an order for relief in the case. QDOS now moves for summary judgment (the “QDOS SJ Motion”) on the ground that Messrs. Hayden and Wiese are not qualifying creditors, thereby entitling QDOS to dismissal of the involuntary petition in this case.

Involuntary Bankruptcy Cases in General; Qualification Requirements

Bankruptcy had its beginnings in England as a remedy available to creditors, after a debtor committed an act of bankruptcy. 2 WILLIAM BLACKSTONE, COMMENTARIES *480 (“․ there must be a petition to the lord chancellor by one creditor to the amount of 100 l, or by two to the amount of 150 l, or by three or more to the amount of 200 l; upon which he grants a commission to such discreet persons as to him shall seem good, who are then stiled commissioners of bankrupt ․”) In modern-day America, the bankruptcy law continues to allow creditors to file a bankruptcy petition against a debtor, and it allows the debtor to contest such petition, in effect asking the bankruptcy court to dismiss the case because the requisite conditions for permitting the case to go forward have not been met.

11 U.S.C. § 303(b)(1) provides that an involuntary case is commenced by the filing with the bankruptcy court of a petition under chapter 7 or 11 “by three or more entities, each of which is either a holder of a claim against [the debtor] that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount ․” If there are fewer than 12 such claim holders, only one qualifying (i.e., qualifying because the claim is noncontingent and undisputed) creditor is required for the statutory requirement to be met. 11 U.S.C. § 303(b)(2).

QDOS's Contentions Regarding Creditor Qualification

QDOS contends in the QDOS SJ Motion that this case falls into the 12-or-more creditor category described in 11 U.S.C. § 303(b)(1) as opposed to the less-than-12 category of 11 U.S.C. § 303(b)(2). Therefore, QDOS reasons, at least three qualifying creditors are required – one or two qualifying creditors will not suffice. QDOS then moves to the next stage of its reasoning, arguing that the involuntary petition against it must be dismissed because two of the four creditors who have joined in the petition, namely, Messrs. Hayden and Wiese, are not qualifying creditors because their claims are both contingent and subject to a bona fide dispute. With the elimination of them as qualifying creditors, only two qualifying creditors remain (Rich Jerskey and Miami Dolphins Ltd.), an insufficient number to permit this case to go forward, thus entitling QDOS to a dismissal of the involuntary petition in this case.

According to QDOS, Messrs. Hayden and Wiese held (as of the petition date) claims of convertible debt (i.e., debt convertible into stock) and therefore such claims were contingent at least until the conversion period expired, because if it were converted into stock, the debt would no longer exist. As of the petition date, it was not clear QDOS would ever be called upon to pay this debt.

QDOS acknowledges that Messrs. Hayden and Wiese contend that they did not hold convertible debt as of the petition date but instead held non-convertible short-term bridge loans. According to QDOS, this proves their claims are the subject of a bona fide dispute, namely, whether the loans were made under the CDO or under a separate bridge loan agreement.

Factual Background

QDOS made a Convertible Debt Offering in 2017 (the “CDO”). Under the terms of the CDO, loans made by investor-lenders had a three-year term from the original receipt of funds and the investor-lenders “may convert the balance of the loans into stock, in full or incrementally, at any time during the [three year] Repayment Period, and in increments of Lender's choosing.” The loans carried an interest rate of 1.29 percent (presumably per annum, although that is not explicitly stated). This interest rate may have been inserted into the transaction for the purpose of avoiding the inadvertent creation of original issue discount, which would have to be picked up and reported by the investor-lenders on a current basis as income for federal income tax purposes pursuant to Internal Revenue Code section 1272 or limiting or minimizing OID upon the obligation's retirement or conversion. There is no indication in the form promissory note that is part of the CDO that interest was to be paid currently. For instance, there is a complete absence of provisions for monthly, quarterly, annual or other regular payment of interest. Rather, accumulated interest would be paid at the time QDOS retired these obligations along with a full repayment of principal, all within three years of QDOS's receipt of the loaned moneys. (Colloquially, a loan where all principal and accrued interest is repaid in a single payment is sometimes referred to as a “bullet loan”).

QDOS alleges that Messrs. Hayden and Wiese participated in the CDO by becoming lenders on August 15, 2017 and August 22, 2017, respectively.

Messrs. Hayden and Wiese dispute this last point, contending that they did not participate in the convertible debt offering but instead made short-term bridge loans (with no right to convert) whose full repayment was due on January 1, 2018. However, they do not dispute that loans made pursuant to the Convertible Debt Offering had a three-year term and were convertible into stock during such three-year term.

Analysis

The plain language of 11 U.S.C. § 303(b)(1) dictates that a creditor holding a claim that is contingent as to liability or the subject of a bona fide dispute cannot be one of the three or more qualifying creditors who must join in an involuntary petition if the case is to go forward and an order for relief entered by the bankruptcy court. “Contingent” is defined in the dictionary as “likely but not certain to happen” and “not necessitated: determined by free choice.” Webster's Ninth New Collegiate Dictionary. Black's Law Dictionary (Rev. 4th Ed.) defines “contingent” as “possible, but not assured.”

Case law interpreting 11 U.S.C. § 303(b)(1) essentially follows and applies these definitions in determining whether a particular claim is contingent. Claims are evaluated as of the time of the filing of the involuntary petition, and a claim is contingent if “it remains uncertain, at the time of the filing of the petition in bankruptcy, whether or not the bankrupt will ever become liable to pay it.” In re All Media Properties, Inc., 5 B.R. 126, 132 (Bankr. S.D. Texas 1980). This interpretation of the term “contingent” has long been the law. In re Mullings Clothing Co., 238 F. 58, 67 (2d Cir. 1916) (“A contingent claim is one as to which it remains uncertain, at the time of the filing of the petition in bankruptcy, whether or not the bankrupt will ever become liable to pay it”). A creditor does not have a claim that is “not contingent as to liability” as required to be eligible to file an involuntary petition if there is some legitimate legal or factual basis for the alleged debtor not to pay the claim. In re John Richards Homes Building Co., LLC, 312 B.R. 849 (E.D. Mich. 2004), aff'd, 439 F.3d 248 (6th Cir. 2006).

The indebtedness of QDOS created under the CDO meets both the dictionary and the case law definition of “contingent.” It meets the dictionary definition because, as of the petition date, it was merely possible, but not assured, that QDOS would be called upon to pay the obligations created pursuant to the Convertible Debt Offering. If converted into stock, QDOS would never have to pay such obligations. Payment of the claim by QDOS was not certain to happen. Payment was not necessitated but would be determined by the free choice of the holder to either exercise or not exercise the conversion right. Under applicable case law, it remained uncertain, as of the petition date, whether or not QDOS would be called upon to pay the obligation. If converted into equity, QDOS would not become liable to pay it.

Close analysis shows that a claim can be contingent irrespective of whether the triggering of liability under such claim is dependent upon the occurrence or the nonoccurrence of an event. For example, as a hypothetical, consider each of the two following transactions: (1) X pays $10,000 to Y on January 1, 2022. Y must pay X $10,500 on January 1, 2023 unless the New York Yankees win the 2022 World Series, in which event Y has no obligation to pay X anything; (2) X pays $10,000 to Y on January 1, 2022. Y gets to keep the $10,000 unless some Major League baseball team other than the New York Yankees wins the 2022 World Series, in which event Y must pay X $10,500 on January 1, 2023. In the first hypothetical, the obligation to pay is triggered by the nonoccurrence of an event (the New York Yankees winning the 2022 World Series). In the second hypothetical, the obligation to pay is triggered by the occurrence of an event, namely, some Major League baseball team other than the New York Yankees winning the 2022 World Series.

Each of these transactions involves a contingent claim. X's right, if any, to a current payment from Y remains uncertain until the 2022 World Series is over. The transactions are absolutely identical in terms of their economic effects and economic reality. The fact that it is a nonoccurrence of an event that triggers a duty to pay in the first hypothetical in no way renders the claim noncontingent. The claim in the first hypothetical is just as contingent as the claim in the second hypothetical. To hold that the claim in the second hypothetical is contingent but the claim in the first hypothetical is noncontingent (or vice-versa) would be to elevate form over substance and to ignore the economic reality that the two hypotheticals are identical in economic terms. As the above hypotheticals demonstrate, distinguishing between the occurrence of events and the nonoccurrence of events as a tool for identifying contingent and noncontingent claims is a distinction that has no basis in reason, logic or economic reality.

Note also in this context that liability under a guarantee –a thing clearly treated as contingent for purposes of 11 U.S.C. § 303(b)(1) – is triggered by the nonoccurrence of an event, namely, the nonoccurrence of the principal obligor's full payment of the guaranteed instrument according to its terms. In re Mavellia, 149 B.R. 301 (Bankr. E.D.N.Y. 1991).

By parallel reasoning, it can be seen that QDOS's liability to pay Messrs. Hayden and Wiese was, as of the petition date, contingent on the nonoccurrence of an event, namely, the nonoccurrence during the three-year term of the loan of an election by Messrs. Hayden and Wiese to convert the loan into QDOS stock. The analysis would be no different if the parties had agreed that Messrs. Hayden and Wiese had the right to convert into stock at any time during the three-year period and that, if such conversion did not occur within that three-year period, QDOS would have to pay them upon expiration of the three-year period the principal amount they originally paid QDOS plus 1.9 percent per annum interest. Essentially, it is the existence of uncertainty as of the QDOS petition date as to whether QDOS would ever to be called upon the repay the moneys conveyed to it by Messrs. Hayden and Wiese that makes their claims against QDOS contingent.

Indeed, what occurred here closely tracks the first hypothetical above. Messrs. Hayden and Wiese transferred money to QDOS. Messrs. Hayden and Wiese and QDOS agreed that QDOS could keep this money without repaying it if Messrs. Hayden and Wiese converted it into stock, but if this did not happen, QDOS would have to pay them the principal sum plus interest on the third anniversary of QDOS's receipt of the money. It is a nonoccurrence of the condition that triggers the obligation and liability to pay.

Messrs. Hayden and Wiese correctly argue that the mere fact a claim is “unmatured” does not make it contingent. However, their claims under the CDO were not merely “unmatured.” Had they exercised their conversion privilege, their claims never would have ripened into the right to receive a payment of money – they would have been permanently transformed into QDOS stock.

The foregoing analysis demonstrates that neither Mr. Hayden nor Mr. Wiese is a qualifying creditor, holding as they do contingent claims against QDOS. However, there is also an additional, independent reason why neither is a qualifying creditor: their claims are the subject of a bona fide dispute as to liability. Messrs. Hayden and Wiese contend that QDOS's liability to them arises not under the Convertible Loan Offering but instead under short-term bridge loan agreements. QDOS acknowledges that Messrs. Hayden and Wiese had discussions with QDOS about a short-term services contract with a loan component in which the Convertible Loan Offering obligations to them would be modified to include a shortened repayment period but contends that this transaction never closed because Messrs. Hayden and Wiese failed to live up to their end of the bargain in terms of providing critical investment-sourcing services for QDOS. This is a bona fide dispute over liability. Messrs. Hayden and Wiese contend QDOS is liable to them under a short-term bridge loan; QDOS denies it has any liability to them under any short-term bridge loan obligation.

The absence of a bona dispute is a jurisdictional prerequisite to maintaining an involuntary case. In re Paczesny, 283 B.R. 715 (Bankr. N.D. Ill. 2002); if a bankruptcy court determines that petitioning creditors’ claims are subject to a bona fide dispute, it is obliged to dismiss the involuntary petition. The court is not permitted to decide the dispute. In re Tama Mfg. Co., Inc., 436 B.R. 763 (Bankr. E.D. Pa. 2010).

Twelve or More Creditors or Fewer Than Twelve?

As discussed earlier, three qualifying creditors are required to join in an involuntary petition if the alleged debtor has twelve or more creditors holding noncontingent, non-disputed claims, but only one such creditor is required if there are fewer than twelve such creditors. Messrs. Hayden and Wiese argue that there are fewer than twelve, so therefore the two remaining qualifying creditors (Jerskey and the Miami Dolphins) are sufficient in number to permit the involuntary case to go forward.

This argument seeks to re-litigate this Court's previous determination in its October 31, 2018 Memorandum Decision and Order that QDOS has between 40 and 50 creditors holding noncontingent, non-disputed claims and therefore is barred by the Law of the Case Doctrine.

Application of Summary Judgment Standards

Summary judgment is appropriate if the party moving for summary judgment shows that there is no dispute as to any material fact and that it is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(a); Fed. R. Bankr. P. 7056. As to the actual terms of obligations under the CDO, there is no dispute as to material facts. Messrs. Hayden and Wiese do not deny that obligations created under the CDO are convertible into QDOS stock within a three-year period; they merely deny that the CDO's terms govern the claims they hold.

Certainly, there is a material fact dispute between QDOS on one hand and Messrs. Hayden and Wiese on the other hand whether the claims they hold arose under the CDO or a bridge loan agreement. However, this does not preclude a grant of partial summary judgment to QDOS because the key issue for purposes of 11 U.S.C. § 303(b)(1) is whether a bona fide dispute exists. Partial summary judgment in this context is proper where there is a showing by the movant that the material facts show that a dispute exists – which they do here – not upon whether the movant can show that there is no dispute as to material facts.

Conclusion

QDOS's request for judicial notice is granted. Petitioning creditors’ limited objection to QDOS's request for judicial notice is overruled on the ground that Federal Rule of Bankruptcy Procedure 7015 is limited in its application to adversary proceedings. Contesting an involuntary petition is not an adversary proceeding but instead is a proceeding within a main bankruptcy case. Fed. R. Bankr. P. 7001.

The Petitioning Creditors hint at certain arguments that QDOS lacks “capacity to appear and defend based upon the voiding of its charter and corporate powers” but then fails to argue the point and (if true) its important ramifications, namely, whether an entity that no longer exists because its charter is voided can be the subject of an involuntary bankruptcy petition. Memorandum in Opposition to QDOS, Inc.’s Motion for Summary Judgment, Docket No. 277, filed July 19, 2021 at page 6 of 35, lines 26-28. For these reasons, the Court overrules this hinted-at argument.

Based upon the foregoing analysis, the Court concludes that QDOS has shown that as a matter of law Messrs. Hayden's and Wiese's claims are subject to a bona fide dispute as to liability or amount and that their claims are contingent as to liability within the meaning of 11 U.S.C. § 303(b)(1).

For these reasons, the Court grants the QDOS SJ Motion in part and awards partial summary judgment in QDOS's favor. The involuntary petition against QDOS is hereby dismissed with prejudice.

The Court denies without prejudice that portion of the QDOS SJ Motion which seeks a determination that Messrs. Hayden and Wiese acted in bad faith, thereby entitling QDOS to an award of punitive damages and sanctions. (The QDOS SJ Motion is somewhat ambiguous on this point, at one point arguing that “punitive damages and sanctions are permitted by law and are warranted by the facts and record in these proceedings” and at another point suggesting that a briefing schedule be established).

The Court will retain jurisdiction and set a hearing on November 22, 2021 at 9:00 a.m. on whether this Court should or should not grant judgment against Messrs. Wiese and Hayden and in favor of QDOS for costs, reasonable attorneys’ fees, actual damages and punitive damages. (If QDOS is seeking costs, reasonable attorneys’ fees and actual and punitive damages against Mr. Jerskey and Miami Dolphins, LLC, it should clarify that in its pleadings. It is not clear to the Court from the QDOS SJ Motion whether QDOS is actually seeking to recover from Mr. Jerskey and Miami Dolphins, LLC). QDOS's brief is due October 11, 2021. Any opposition to the QDOS brief is due October 29, 2021. QDOS's reply to any opposition is due November 12, 2021.

Following the November 22, 2021 hearing, the Court will issue a final order in this case.

IT IS SO ORDERED.

Mark S. Wallace, United States Bankruptcy Judge