THE SMALL BUSINESS BANKRUPTCY BLOG
Planning to Dismiss an Existing Chapter 11 and Refile to Elect Subchapter V? Read In re Crilly, and Don't Overplay Your Hand
The SBRA was designed to broaden the opportunity for small businesses to successfully utilize the benefits of chapter 11 and it created Subchapter V for small business debtors. The SBRA gives the small business debtor a better chance to unburden itself from unmanageable debt and to make a fresh start. It costs less than a traditional Chapter 11, it proceeds at a rocket’s pace compared to a traditional Chapter 11, and it permits business owners to retain their ownership interests. Consequently, businesses and their owners elect Subchapter V when possible. In one recent case, the debtors decided to take advantage of Subchapter V by dismissing their pending traditional Chapter 11 and then refiling with a Subchapter V election. It did not work out the way the debtors had hoped.
One advantage of bankruptcy is that the “automatic stay” under 11 U.S.C. § 362 goes into effect upon the commencement of the case and it lasts until the case is closed or dismissed. The automatic stay prohibits most creditors from continuing collection activities against the debtor, and the stay can provide welcome relief to the debtor as it formulates a plan to bring its operations back to profitability. In In re Crilly, No. 20-11637-SAH, 2020 Bankr. LEXIS 1718 (Bankr. W.D. Okla. June 30, 2020), the debtors had a traditional chapter 11 pending, but then decided to dismiss and refile to take advantage of Subchapter V. However, because the Crillys had a prior bankruptcy case pending during the year preceding the filing of their new bankruptcy case, the automatic stay of 11 U.S.C. § 362(a) was set to terminate thirty days after the filing of the second case unless the Crillys could establish that the filing of the second case was in good faith. Accordingly, the debtors filed a motion seeking a continuation of the automatic stay, arguing that the second case was filed in good faith. The United States Trustee ("UST") and two creditors objected to the Motion—claiming the second case was filed in bad faith. The objecting creditors had a previous motion for relief from the automatic stay pending at the time that the original case was dismissed.
The Court found in favor of the UST and the objecting creditors. The Court noted that there is a presumption of bad faith in a second filing, and this presumption works in favor of all creditors unless the debtors demonstrate (1) there has been a substantial change in their financial or personal affairs or (2) the second case will be concluded with a confirmed plan they can perform. Additionally, if a creditor had a motion for relief from stay pending when the original case was dismissed, then there is a presumption of bad faith with respect to that particular creditor, and the burden is on the debtor to overcome the presumption. In this case, the Court considered the totality of the circumstances and found that the Crillys could not meet their burdens. The second case was filed just six hours after the original case was dismissed. So, the debtors could not show that they experienced a substantial change in their financial or personal affairs in those few hours. Further, the original case has a long history, with six amended plans and a previous order denying confirmation for lack of feasibility. Moreover, the Subchapter V Trustee testified that he did not have high hopes for achieving a consensual plan. The two creditors who had objected were family members—Mrs. Crilly’s mother and stepfather. Sometimes, making a deal with one’s parents or in-laws can be infinitely more difficult than making a deal with a bank. The Court found that the disgruntled family members held 90% of the debt and a deal was unlikely, that the Crillys could not confirm a plan during the original case, that they paid their attorney $50,000 in the few hours between the first case and the second case, and that they manipulated the Bankruptcy Code for twenty months in the first case. So, the Court did not extend the stay.
This case is an extreme example, but debtors and their professionals need to be aware of the potential pitfalls in any case, and this case provides an interesting discussion on the interplay between the SBRA and § 362(c)(3).
The SBRA deals the debtor a pretty good hand, but you still have to know how to play it.