THE SMALL BUSINESS BANKRUPTCY BLOG
Muddied Waters: Courts Disagree Whether a Debtor Must Be Operating to Qualify for Subchapter 5 Relief
The SBRA defines a qualifying "debtor" as "a person engaged in commercial or business activities." 11 U.S.C. § 1182(1)(A). A few months ago, I cited In re Blanchard, No. 19-12440, 2020 Bankr. LEXIS 1909 (Bankr. E.D. La. July 16, 2020), In re Wright, No. 20-1035, 2020 Bankr. LEXIS 1240 (Bankr. D.S.C. Apr. 27, 2020), and In re Bonert, No. 2:19-BK-20836, 2020 Bankr. LEXIS 1783 (Bankr. C.D. Cal. June 3, 2020). These cases supported the position that current operations are not necessary for a debtor to qualify under the SBRA. In other words, if the business is no longer operating but the debtor files bankruptcy to address residual business debts, then the debtor is "engaged in commercial or business activities" and thus may still qualify for Subchapter V relief.
But not everywhere. . .
In In re Thurmon, 2020 Bankr. LEXIS 3422 (Bankr. W.D. Mo. Dec. 8, 2020), the court sustained the United States Trustee's objection to the debtors' Subchapter V election because the debtors had ceased their business operations prepetition, sold their assets, and had no intention of resuming operations. Because the SBRA does not define "engaged in commercial or business activities," the court looked to analogous cases in Chapter 12 which require family farmers to "conduct" farming operations to qualify for relief under Chapter 12. After considering these cases, the court found that the Thurmons were not engaged in commercial or business activities when they filed bankruptcy because they had already sold the business with no intent to restart it and were otherwise not active or involved in any commercial or business activities. From a practical standpoint, the decision was not a disaster for the Thurmons because the court nonetheless confirmed the plan under a traditional Chapter 11 analysis; however, it could have been very difficult for them had there been other issues.
So, what is the work around in a case where the debtor is selling its assets and ceasing operations? File bankruptcy before the sale of the business assets and include the sale as part of the plan.
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.