By: Donald L Swanson
When a Subchapter V debtor is removed from possession under § 1185(a), what can the Subchapter V trustee do with debtor’s assets and operations?
Duties, Rights, Powers and Functions
Under § 1184, certain duties of a trustee are delegated to the Subchapter V debtor, “including operating the business of the debtor.” Once the debtor is removed from possession, the “duty” of “operating the business of the debtor” reverts to the Subchapter V trustee (§ 1183(b)(5)).
But what about all the “rights . . . powers . . . functions . . . of a trustee” that are delegated to the debtor in possession under § 1184?[Fn. 1] Do these rights, powers and functions also revert to the Subchapter V trustee upon debtor’s removal? What about, for example, a trustee’s:
- right to sell assets or obtain credit, outside the ordinary course, under § 363(b) or § 364(b);
- power to avoid transfers under §§ 544, 545, 547, 548, 549 or 550; and
- function of representing the bankruptcy estate, under § 323?
Conventional wisdom is that all duties, rights, powers and functions delegated to the debtor by § 1184 revert to the Subchapter V trustee upon removal of the debtor from possession. Let’s call this the “Conventional Model.”
In re Coeptis Equity Fund LLC
The Conventional Model is supported by the March 15, 2023, opinions of the Ninth Circuit Court of Appeals in the Subchapter V case of In re Coeptis Equity Fund LLC.[Fn. 2] In that case, Debtor failed to respond to two separate orders to show cause. And so the Bankruptcy Court:
- removed the Debtor from possession;
- thereafter, approved the Subchapter V Trustee’s sale of Debtor’s real estate assets under § 363; and
- later, converted the Subchapter V case to a case under Chapter 7.
Debtor appealed the Bankruptcy Court’s orders, but both the Ninth Circuit BAP and the Ninth Circuit Court of Appeals affirmed in “Not for Publication” opinions.[Fn. 2]
While the Coeptis Equity appellate opinions have limited precedential value, the reality that remains is this:
- the Bankruptcy Court removed Debtor from possession under § 1185(a) and then approved the Subchapter V trustee’s sale of assets under § 363(b); and
- such actions survive appeals to both the Ninth Circuit BAP and the Ninth Circuit Court of Appeals.
Impotent Trustee Model
There is, however, a minority view. Let’s call it the “Impotent Trustee Model.” It goes something like this. After removal of the debtor from possession, the Subchapter V trustee:
- can exercise only those duties specifically named in § 1183(b) (the most significant of which is “operating the business of the debtor”);
- cannot do such things as liquidate assets or avoid transfers under Chapters 3 or 5 of the Bankruptcy Code—because those things aren’t specifically named in § 1185(b); and
- is powerless to resolve the case, since only the debtor can file a Subchapter V plan (§ 1189(a)).
I’ve always thought the Impotent Trustee Model to be bad bankruptcy policy (and more-than-a-little bizarre) for both practical and textual reasons and because of a policy tradeoff inherent in Subchapter V.
–Practicalities
The rights, powers and functions bestowed by Chapters 3 and 5 of the Bankruptcy Code upon the “trustee” are necessary and essential in every Chapter 11 case. And such rights, powers and functions need to be held by someone . . . at all times.
Allowing those Chapters 3 and 5 rights, powers and functions to evaporate into thin air, even for a short time, invites abuse and disaster.
And for a recalcitrant Subchapter V debtor with no strategy but delay, debtor’s removal (under the Impotent Trustee Model) becomes truly a wonderland.
–Code Text
While I’ve heard a number of people champion the Impotent Trustee view, I’ve never seen or heard any explanation of its statutory basis. I have heard people say something like:
- “No Subchapter V language incorporates by reference the rights, powers or functions provided in Chapters 3 or 5 of the Bankruptcy Code.”
But that’s merely a conclusory statement without support.
Here’s a contrary view of Bankruptcy Code provisions that support the Conventional Model:
- the grants of rights, powers and functions to the “trustee” in Chapters 3 and 5 are self-executing;
- there is, for example, no separate statute granting those rights, powers and functions to a regular Chapter 11 trustee; and
- similarly, there is no separate statute withholding such rights, powers and functions from a Subchapter V trustee after debtor’s removal.
And there is little-to-no difference in removal-related statutes between regular Chapter 11 and Subchapter V. For example:
- Words delegating the trustee rights, powers, functions and duties to the debtor in possession are nearly identical in § 1107(a) and in § 1184.
- Words establishing standards for removing a debtor from possession are the same in § 1104(a) and § 1185(a)—i.e., “for cause, including . . . “
- Enumerated powers for a Subchapter V trustee after removal are exactly the same as enumerated powers for a regular Chapter 11 trustee, with only one exception—a Subchapter V trustee cannot file a plan.
–Policy Tradeoff
Here’s a policy tradeoff inherent in Subchapter V:
- upon removal from possession, the debtor has one remaining tool—i.e., to file a plan;
- so, if debtor wants to have any effect or control on the bankruptcy case after removal, the debtor had better file a plan quickly that has a fighting chance at confirmation; and
- otherwise, the Subchapter V trustee after removal will do what trustees do.
Conclusion
The In re Coeptis Equity Fund LLC Bankruptcy Court, Ninth Circuit BAP and Ninth Circuit Court of Appeals opinions support the Conventional Model of a Subchapter V trustee’s rights, powers and functions after removal of the debtor from possession.
Here’s a “Thank you” to those courts for that!
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Footnote 1. 11 U.S.C. § 1184 provides, “Rights and powers of a debtor in possession. Subject to such limitations or conditions as the court may prescribe, a debtor in possession shall have all the rights, other than the right to compensation under section 330 of this title, and powers, and shall perform all functions and duties, except the duties specified in paragraphs (2), (3), and (4) of section 1106(a) of this title, of a trustee serving in a case under this chapter, including operating the business of the debtor.”
Footnote 2. Case numbers for the In re Coeptis Equity Fund LLC appeals at both the Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals are 22-1135, 22-1136 & 22-1138. Those appeals were taken from rulings by the Northern California Bankruptcy Court in Case No. 21-30726.
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