Why Courts in the Eleventh Circuit Should No Longer Apply Denham’s Small and Recurring Numerosity Exclusion
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An involuntary bankruptcy case is typically commenced by a petition joined by at least three petitioning creditors.[1] However, an involuntary petition may be filed by a single petitioning creditor if the debtor has 11 or fewer “qualified” creditors.[2] This is often called the “numerosity” requirement. The Bankruptcy Code, in Section 303(b)(2), expressly defines which creditors count in the numerosity requirement. In determining whether there are 11 or fewer creditors, certain creditors are ignored, including (a) any employees of the debtor who are also creditors,[3] (4) any “insiders” of the debtor who are creditors,[4] and (3) any creditors who received voidable transfers under §§ 544, 545, 547, 548, or 724(a) of the Bankruptcy Code.[5]
Some courts have judicially-legislated an additional exclusion not found in the Code. In determining whether there are twelve or more creditors, the overwhelming authority throughout the country is that small and recurring debts are counted because the Code does not specifically exclude them from the numerosity count.[6] To be clear, the Code does not state that small and recurring creditors should be excluded, and does not even define a monetary limitation of what should be considered “small and recurring.”[7] However, some courts in the Eleventh Circuit, relying on Denham,[8] do not count “small and recurring” debts in the numerosity calculation.
This article will first examine the Denham case, and then provide reasons why courts in the Eleventh Circuit should no longer apply Denham when determining whether a creditor should be included in the numerosity count.
I. DENHAM V. SHELLMAN GRAIN ELEVATOR, INC.
Courts in the Eleventh Circuit that have applied the “small and recurring” exception relied on Denham v. Shellman Grain Elevator, Inc. (“Denham”), a former Fifth Circuit case that is binding on bankruptcy courts in the Eleventh Circuit.[9] In Denham, the Fifth Circuit, interpreting Sections 56 and 59 of the now-superseded Bankruptcy Act, held that recurring claims under $50.00 should not be counted in the numerosity count.[10] The court was concerned that “small current debts, contracted to be paid monthly and on demand, such as claims for rent, groceries, drugs, etc., [could] be resorted to by an insolvent for the purpose of increasing the number of his creditors to twelve or more in order to defeat an involuntary petition by a large creditor.”[11] In Denham, the alleged debtor averred the existence of eighteen creditors holding a total indebtedness of $467.13 – seven of which held claims for less that $10 and six held claims for less than $25.[12] The court opined that the evidence supported the Bankruptcy Referee’s finding that a scheme existed to manufacture insignificant claims to avoid the letter and spirit of the involuntary feature of the Bankruptcy Act of 1898, Section 59(b).[13]
The Denham court provided the following rationale “by analogy” for excluding “small and recurring” claims:
It is our belief that . . . it was not the intent of Congress to allow recurring bills such as utility bills and the like to create a situation which, by refusal of these small creditors to join in an involuntary petition, can defeat the use of the Bankruptcy Act by a large creditor, as in the subject case . . . . Section 56(c) (11 U.S.C. § 92) of the Bankruptcy Act indicates clearly the intention of Congress concerning small claims and how they should be treated. This section states: “Claims of $50 or less shall not be counted in computing the number of creditors voting or present at creditors’ meetings, but shall be counted in computing the amount.” This section of the Act is only mentioned to show by analogy that a majority vote in number cannot be arrived at by the use of claims under $50.00.[14]
This analogy to Section 56(c) of the Act constitutes the only statutory-hook of the Denham opinion.
II. WHY THE ELEVENTH CIRCUIT SHOULD ABANDON DENHAM
There are several reasons why Denham should not be followed anymore. First, its only link to statute has been disconnected by Congress. Denham’s cross-reference to Section 56(c) is an apparent attempt by the court to “anchor” its exception to language of the Act. However, Congress deleted the $50 classification for counting a quorum at a meeting of creditors, and the rule is not in the Code.[15] Thus, the reasoning of Denham, as applied to the Code, is seriously flawed. Denham’s rationale is no longer supported by statute, if it ever was. Denham is a ship without an anchor. Its one loose tether was cut by Congress.
Another reason Denham should no longer be followed is that the court was interpreting Section 59 of the Bankruptcy Act. It was not interpreting the Bankruptcy Code. Congress replaced the Bankruptcy Act with the Bankruptcy Code in 1978. Congress was aware of the Denham case when it replaced the Act with the Code. If Congress intended for the “small and recurring” exception to continue, it would have included it in Section 303 of the Code. Congress did not. If Congress intended for courts to discriminate against claims below a certain value threshold, it would have stated it in the Code. But Congress did not. Therefore, Denham’s interpretation is no longer applicable.
Section 303 articulates all of the exclusions that Congress intended, and the “small and recurring” exception is not one of the enumerated exceptions. Therefore, applying the exception now is to ignore Congress’s unambiguous intent as explicitly prescribed in the Code. As expressed by the United States Supreme Court in U.S. v. Ron Pair Enterprises, Inc., “[t]he plain meaning of legislation should be conclusive, except in the rare cases [in which] the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters.”[16] Legislation is the function of Congress, not the courts.[17]
A final reason exists. Applying Denham forces a court to arbitrarily establish a monetary threshold for what constitutes a small or de minimis claim.[18] The Code neither provides a monetary threshold, nor provides any guidance as to how the court should determine such a threshold on a case-by-case basis. There is simply no statutory support that would permit courts to arbitrarily fix a set sum and classify that sum as de minimis to disqualify creditors.[19]
Despite the aforementioned flaws, some recent cases in Florida hold that Denham’s small and recurring exclusion is still the law of the Eleventh Circuit. However, the Eleventh Circuit has not itself decided on this issue, and the majority of other courts across the country have rejected Denham and applied the Code as written.[20] The Seventh, Eighth, and Ninth Circuits have expressly rejected the “small and recurring” exception because Congress did not expressly adopt the “small and recurring” exception into the language of the Code, and the fact that the Code makes no distinction between small and large claims suggests that Congress did not intend for there to be any distinction.[21] In In re Okamoto, the Ninth Circuit provided a well-reasoned analysis why Denham should be rejected:
We are not persuaded by Denham, for it appears to us the Denham court ignored unambiguous Congressional direction. The Congress has explicitly prescribed the procedure that must be followed when less than three creditors join in the petition. In such circumstances, the Act provides that the alleged bankrupt must have less than twelve creditors and expressly excludes certain types of creditors from the required computation. Since Congress made no distinction between large and small claims, we cannot arrogate unto ourselves the power to do so and thereby engraft an additional exception to the Act. Hornblower’s argument properly should be addressed to the Congress. Our conclusion is reinforced by the fact that Congress has clearly and expressly excluded small claims when it has intended to do so. See Bankruptcy Act § 56(c), 11 U.S.C. § 92(c).[22]
Despite the sound logic expressed in Okamoto, some courts in the Eleventh Circuit have found reason to apply Denham.
One such case is In re Smith.[23] There, the Bankruptcy Court for the Middle District of Florida, found a way to explain how Denham can remain binding precedent even though the Code has superseded the Act:
Even though Denham was decided under the Bankruptcy Act of 1898, it is still good law as the Bankruptcy Code, like the Bankruptcy Act of 1898, requires three petitioning creditors to maintain an involuntary petition if the debtor has more than twelve creditors. § 303(b)(1). Although Denham was decided by the Fifth Circuit before the Eleventh Circuit was created, it is still precedent in this Court.[24]
The court in In re Smith posits that because both the Act and the Code contain the numerosity requirement, then the cases interpreting the exclusions to the numerosity requirement before Congress enacted the Code should remain good law. This logic is flawed.
First, the majority of the Circuit Courts reject the “small and recurring” exception. Second, and more importantly, Congress abolished the numerosity exclusions found in the Act and replaced them with new express exclusions in the Code. When re-writing the exclusions, Congress had the opportunity to insert the “small and recurring” exception if it intended for it to be an exclusion to the numerosity calculation. It did not add it. Congress’ choice not to add it to the Code speaks loud and clear. Congress did not intend for Denham to remain good law and it did not intend for the “small and recurring” exception to be a part of the Code. It is undeniable that the “small and recurring” exception is not in the Code.
III. CONCLUSION
For these reasons, the courts in the Eleventh Circuit should distinguish Denham as no-longer-binding precedent, follow the Code, and include small and recurring creditors in the numerosity count. There are simply no indicia in the Code, or evidence of Congress’s intent, as to the amount of a claim that should be excluded from eligibility. Moreover, to judicially legislate an arbitrary cap would overly-complicate the administration proceedings.
[4] 11 U.S.C. § 101(31) (defining insider to include relatives, general partners, and relatives of general partners, partnerships in which the debtor is a general partner, and corporations of which the debtor is a director, officer, or person in control).
[6] See Matter of Rassi, 701 F.2d 627 (7th Cir. 1983) (stating that holders of bona fide small, de minimus, and recurring claims are counted in the number of creditors needed to file an involuntary petition because Congress has not specifically authorized an exclusion for these debts).
[7] In re Elsa Designs, Ltd., 155 B.R. 859, 865 (Bankr. S.D. N.Y. 1993) (citing In re Hoover, 32 B.R. 842, 847 (Bankr. W.D. Okla. 1983)(“Under the broad definition of claim as provided in 11 U.S.C. § 101(15) ‘it would stretch judicial interpretation to the breaking point to read into the definition an exception based upon the amount of the claim. If a creditor has a claim, and the creditor is not one that would be excluded pursuant to the provisions of § 303(b)(2), then that creditor should be counted in determining the sufficiency of a petition filed under that section.’”)
[8] Denham v. Shellman Grain Elevator, Inc., 444 F.2d 1376 (5th Cir. 1971).
[9] See id.
[10] Id. at 1379.
[11] Id.
[12] Id. at 1378.
[13] Id. at 1379.
[14] Id. at 1379.
[15] In re Reid, 107 B.R. 79, 82 (Bankr. E.D. Va. 1989); In re Elsa Designs, Ltd., 155 B.R. 859, 865 (Bankr. S.D.N.Y. 1993) (“Section 56(c), however, has no counterpart under the Code, and Rule 2007 of the Federal Rules of Bankruptcy Procedure has deleted the provision in its forerunner, Bankruptcy Rule 207, which prohibited a holder of a claim less than $100 from voting at a creditors’ meeting.”).
[16] U.S. v. Ron Pair Enterprises, Inc., 489 U.S. 235 (1989).
[17] In re Sedona Inst., 220 B.R. 74, 84 (Bankr. App. 9th Cir. 1998).
[18] See, e.g., In re Smith, 123 B.R. 423, 425 (Bankr. M.D. Fla. 1990) (recognizing claims of up to $275 as de minimis); see also In re Moss, 249 B.R. 411, 419 (Bankr. N.D. Tex. 2000) (narrowly construing Denham because it contravenes the language of the statute, refusing to recognize $275 claims as de minimis, but finding recurring claims amounting to $20.99, $58, $10.62, and $25 were de minimis); In re Smith, 415 B.R. 222, 232 (Bankr. N.D. Tex. 2009) (finding as de minimis recurring claims in the amounts of $67.70, $43, $125.99, and $187.39).
[19] See In re Fischer, 202 B.R. 341 (E.D.N.Y. 1996) (rejecting the “small and recurring” exception).
[20] See In re Sedona Inst., 220 B.R. at 83.
[21] Matter of Rassi, 701 F.2d 627, 632 (7th Cir. 1983) (“[C]ongress has not specifically authorized exclusion, and in the absence of any indication that Congress intended this exclusion, we have no authority to engraft it onto those that Congress expressly provided . . . We hold that bona fide, small, and recurring claims must be included in the § 303(b) count.”); see also In re Okamoto, 491 F.2d 496 (9th Cir. 1974); Grigsby–Grunow Co. v. Hieb Radio Supply Co., 71 F.2d 113 (8th Cir. 1934); Theis v. Luther, 151 F.2d 397 (8th Cir. 1945), cert. denied, 327 U.S. 781 (1946).
[22] In re Okamoto, 491 F.2d at 498.
[23] In re Smith, 123 B.R. 423, 425 (Bankr. M.D. Fla. 1990)(Judge Paskay) aff’d, 129 B.R. 262 (M.D. Fla. 1991).
[24] Id.