THE SMALL BUSINESS BANKRUPTCY BLOG
The Small Business Reorganization Act of 2019 (the “SBRA”) added new Subchapter V to Chapter 11. The SBRA offers small business debtors a streamlined Chapter 11 procedure that should be less costly and time-consuming than a traditional case, and it offers the business owner a better opportunity to retain his or her company going forward. To be eligible for Subchapter V, a debtor must have “noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition . . . in an amount not more than $7,500,000.” 11 U.S.C. § 1182(1)(A). This debt ceiling will fall back down to approximately $2.7 million in the spring of 2021.
Debt limitations are also features of Chapters 12 and 13, and they are the subject of litigation in those chapters. Unquestionably, the debt limitation will be the occasional subject of Subchapter V litigation as well. A recent case provides timely guidance for practitioners, including a court’s view on how PPP loans are treated under § 1182. In In re Parking Mgmt., No. 20-15026, 2020 Bankr. LEXIS 2309 (Bankr. D. Md. Aug. 28, 2020), the debtor had debts of almost $9,000,000, and its eligibility under subchapter V was questioned by the United States Trustee and a major creditor. However, the debtor argued that two types of its debt were unliquidated and/or contingent and thus should be removed from the debt limit calculation: (1) lease rejection damages and (2) the debtor’s obligation to repay its PPP loan. If these debts were found to be contingent or unliquidated, then the debtor would be eligible for a Subchapter V filing.
The lease rejection damages arose simply from the debtor’s decision to reject 12 leases as part of its first day filings. The court found such damages to be contingent. Even though § 365 treats lease rejection damages as a prepetition breach of contract, the rejection is not effective until court approval. In Parking Mgmt., the court held that any lease rejection claims were contingent obligations until the court approved the rejection. Consequently, the court held that such claims are not considered in determining the debtor’s eligibility for Subchapter V.
The debtor also listed a $1.8 million prepetition PPP loan that had not been repaid as of the petition date. To determine whether the debtor would be eligible for Subchapter V, the court had to decide whether the PPP is a noncontingent, liquidated debt as of the petition date. The court reviewed the history and the purpose of the Paycheck Protection Program, which includes loan forgiveness under certain circumstances. The court determined that the debtor's liability to repay the PPP is dependent on the debtor using the funds for ineligible expenses or failing to meet employee retention criteria. Because the debtor's liability to repay the PPP relies on some future extrinsic event which may never occur, the court determined that the obligation was contingent as of the petition date. The court further found that the PPP debt was unliquidated as of the petition date because it was not then known whether the debtor would use the PPP funds for ineligible expenses or would fail to maintain employee staffing levels in accordance with the PPP. Accordingly, the PPP obligation was not included in the Subchapter V debt limits and the debtor was eligible to take advantage of the SBRA.
Because so many small business debtors will have taken advantage of the PPP, In re Parking Mgmt. may be an important case to help debtors stay under the debt limitations of Subchapter V.
Some debtors with a pending Chapter 11 have made a small business election later in the case; others have opted to dismiss, refile their Chapter 11, and make the election upon refiling. It's a tactical decision. Here's a case that gives the practitioner some food for thought.
The SBRA is a great resource to assist a distressed business, but it imposes deadlines to keep the case moving expeditiously. For example, a plan must be proposed within 90 days of the order for relief. When a debtor has a case pending and later elects to proceed under Subchapter V, we have seen courts reset the deadlines. See, e.g., In re Twin Pines, LLC, No. 19-10295-j11, 2020 Bankr. LEXIS 1217 (Bankr. D.N.M. Apr. 30, 2020); In re Ventura, 615 B.R. 1 (Bankr. E.D.N.Y. 2020); In re Bello, 613 B.R. 894 (Bankr. E.D. Mich. Mar. 27, 2020). However, a recent decision from the Southern District of Florida shows that this outcome is not a given—the court dismissed the case because the deadlines had already passed when the election was made.
In In re Seven Stars on the Hudson Corp., No. 19-17544-SMG, 2020 Bankr. LEXIS 2106 (Bankr. S.D. Fla. Aug. 7, 2020), the debtor's Chapter 11 was pending for about a year before the debtor made its Subchapter V election. Subchapter V, however, requires a debtor to file a plan not later than 90 days after the order for relief (§1189(b)), and it requires the court to hold a status conference not later than 60 days after the order for relief (§ 1188(a)). In Seven Stars, the order for relief was entered on June 5, 2019. Thus, upon amending its petition to elect to proceed under Subchapter V more than a year into its case, the debtor immediately put itself in default of the requirements of §§ 1188(a) and 1189(b).
After making the election, the court dismissed the case because the deadlines had already passed and the debtor failed to show cause for extending them. The court noted that, to extend the deadlines, the debtor must show “circumstances for which the debtor should not justly be held accountable.” The court stated:
Where a debtor elects to proceed under Subchapter V after the statutory deadlines have passed, it cannot be said that the need for an extension of these deadlines is attributable to circumstances for which the debtor should not justly be held accountable. The debtor should justly be held accountable for these circumstances; the debtor made this election after the deadlines expired. That decision by a debtor should not foist upon creditors all of the added powers of a Subchapter V debtor without one of the most significant protections afforded to creditors under the SBRA — that the case proceed expeditiously.
Id. at *21-22. Although the election was made more than a year of the bankruptcy petition and only three weeks after the court ruled that the debtor incurred a $130,000 administrative claim, the court did not find a lack of good faith on the part of the debtor. The court found:
Where a debtor elects into Subchapter V after expiration of the statutory deadlines, however, the debtor should justly be held accountable for those circumstances, because the debtor created them. It was the debtor that made the decision to elect into Subchapter V after expiration of these deadlines. No circumstances beyond the debtor's control caused the debtor to make that decision.
Id. at *18-19.
Although the case has been dismissed, I suspect that the debtor will refile the Chapter 11 and make the Subchapter V election upon refiling.
The Courts Are Providing Clarity: Non-operating Businesses and Their Owners Also Qualify under the Small Business Reorganization Act
Another case has held that nonoperating businesses and their owners may qualify for relief under the Small Business Reorganization Act of 2019. The SBRA defines a qualifying "debtor" as "a person engaged in commercial or business activities." 11 U.S.C. § 1182(1)(A). There has been some debate as to whether this language requires a debtor to be currently engaged in commercial or business activities. Three courts have now found that nothing in the legislative history of the SBRA or in the statute itself limits its application to debtors currently engaged in business or commercial activities. The latest case is In re Blanchard, No. 19-12440, 2020 Bankr. LEXIS 1909 (Bankr. E.D. La. July 16, 2020)(finding that current operations are not necessary to qualify under the SBRA but noting that a majority of the debtors' debts stemmed from operation of both currently operating businesses and non-operating businesses). The other two cases are In re Wright, No. 20-1035, 2020 Bankr. LEXIS 1240 (Bankr. D.S.C. Apr. 27, 2020) (finding that a debtor who sought to address residual business debt he incurred from non-operating companies to be "engaged in commercial or business activities" without reliance on a coexistent case) and In re Bonert, No. 2:19-BK-20836, 2020 Bankr. LEXIS 1783 (Bankr. C.D. Cal. June 3, 2020)(finding proper an election to proceed under the SBRA to address the debtors' liabilities stemming from their prior operation of a bakery).