Bankruptcy Judge Benjamin A. Kahn of Greensboro, N.C., ruled that the redesignation of a typical small business case under newly enacted subchapter V of chapter 11 does not impair a creditor’s constitutional rights.
Judge Kahn also found no constitutional prohibition in applying subchapter V to contracts and property rights in place before the enactment of the Small Business Reorganization Act of 2019, or SBRA.
The SBRA
The President signed the SBRA into law on August 23. It became effective on February 19. The SBRA is codified as subchapter V in chapter 11, 11 U.S.C. §§ 1181 – 1195.
Theoretically, at least, a small business debtor can speed through chapter 11 without a creditors’ committee and without a disclosure statement. It is even possible for a debtor to confirm a plan without a vote of creditors. A debtor with aggregate, noncontingent, liquidated secured and unsecured debt of less than $2,725,625 is eligible to file under the SBRA. See Section 101(51D).
The Debtor’s Petition
The corporate debtor in Judge Kahn’s case owned three separate parcels of real property rented to farmers. To halt two pending foreclosures, the debtor filed a chapter 11 petition on February 10, nine days before the SBRA became effective.
In the original petition, the debtor designated itself as a small business debtor as defined in Section 101(51D). The designation, however, was improper because the statute at that time broadly excluded owners or operators of real property from being small business debtors.
On February 13, the bankruptcy administrator objected to the debtor’s classification as a small business debtor.
The definition changed on February 19. Now, the definition of “small business” under Section 101(51D) only excludes debtors whose primary business is owning “single asset real estate,” or SARE.
In his February 28 opinion, Judge Kahn determined that the debtor’s ownership of “at least two separate parcels” meant that it was not a SARE and thus qualified under amended Section 101(51D).
Taking advantage of the effective date of the SBRA on February 19, the debtor amended its petition on February 24 to designate itself as a small business debtor under subchapter V.
The Constitutional Issues
For Judge Kahn, the first question was whether subchapter V may be applied to all aspects of the debtor/creditor relationship arising before enactment of the SBRA.
The Supreme Court, he said, provided guidance in two cases, Landgraf v. USI Film Products, 511 U.S. 244 (1994); and U.S. v. Security Industrial Bank, 459 U.S. 70 (1982).
Landgraf taught that a statute “will not be construed to have retroactive effect unless [its] language requires this result.” Landgraf, 511 U.S. at 264. Security National Bank was more on point because it dealt with retroactivity of the Bankruptcy Reform Act of 1978. Security National grappled with the question of whether the court could avoid a lien under the Bankruptcy Code that could not have been avoided under the former Bankruptcy Act.
Drawing a distinction between altering contractual rights and property rights, the high court in Landgraf precluded the destruction of property rights.
Judge Kahn said that the case before him “create[d] none of the taking or retroactivity concerns expressed by the Court in Landgraf and Security Industrial Bank.” Subchapter V, he said, incorporates most of existing chapter 11. With two exceptions not applicable to the case at hand, he said, it “does not alter the rubric under which debtors may affect pre-petition contractual rights of creditors, much less vested property rights.”
Unlike chapter 11, where there must be an accepting class to confirm a plan, a debtor in subchapter V can confirm a plan without an accepting class. See Section 1191(b). The ability to confirm without an accepting class, Judge Kahn said, does “not alter [pre-existing contractual] rights.” The statute, he said, amends the “fair and equitable” requirement “by substituting the disposable income requirement in lieu of the absolute priority rule under § 1129(b)(2)(B) and (C), respectively.”
Judge Kahn said that the “alteration of the definition of fair and equitable in an existing case does not, standing alone, amount to an impermissible retroactive taking.”
In sum, Judge Kahn said it was “not a case in which the Court is asked to apply new law retroactively in violation of the mandates of Landgraf or Security Industrial Bank.” To rule on the disputes before him, he therefore applied subchapter V, the law in effect when rendering the decision.
A Small Business Debtor?
When the debtor filed its petition before the effective date of the SBRA, the debtor did not qualify as a small business debtor. When the bankruptcy administrator’s objection came to the court for hearing, the statute had changed, so at that point the debtor qualified as a small business debtor under the new law.
To determine the debtor’s qualification, the question for Judge Kahn was this: Does the court apply the statute in effect when the petition was filed, or the law in effect at the time of the hearing?
To answer the question, Judge Kahn consulted Bankruptcy Rule 1020(a). He focused on the last sentence in Rule 1020(a), which reads: “Except as provided in subdivision (c), the status of the case as a small business case shall be in accordance with the debtor’s statement under this subdivision, unless and until the court enters an order finding that the debtor’s statement is incorrect.”
According to Judge Kahn, the rule means that “the original designation controls unless and until the court enters an order finding that a debtor’s election is incorrect.” Consequently, the debtor was a small business debtor at the time of the hearing on the objection by the bankruptcy administrator.
At the time of the hearing, the debtor qualified as a small business debtor because the definition had changed on February 19. Furthermore, Bankruptcy Rule 1009(a) allows a debtor to amend a petition or schedule at any time before a case is closed.
Citing In re Progressive Solutions Inc., 18-14277 (Bankr. C.D. Cal. Feb. 21, 2020), Judge Kahn ruled that the debtor “was entitled to amend its statement to elect subchapter V.” To read ABI’s report on Progressive, click here.
Judge Kahn overruled the bankruptcy administrator’s objection. Because the debtor was entitled to make the election and the designation was “not incorrect,” he held that the debtor was a small business debtor.
Prediction
We will not be surprised if there are other challenges and appeals regarding the applicability of subchapter V to pending cases. We also expect creditors to question whether the SBRA’s more liberal confirmation standards impair constitutional rights with regard to rights or property interests established before enactment.
Bankruptcy Judge Benjamin A. Kahn of Greensboro, N.C., ruled that the redesignation of a typical small business case under newly enacted subchapter V of chapter 11 does not impair a creditor’s constitutional rights.
Judge Kahn also found no constitutional prohibition in applying subchapter V to contracts and property rights in place before the enactment of the Small Business Reorganization Act of 2019, or SBRA.
The SBRA
The President signed the SBRA into law on August 23. It became effective on February 19. The SBRA is codified as subchapter V in chapter 11, 11 U.S.C. §§ 1181 – 1195.
Theoretically, at least, a small business debtor can speed through chapter 11 without a creditors’ committee and without a disclosure statement. It is even possible for a debtor to confirm a plan without a vote of creditors. A debtor with aggregate, noncontingent, liquidated secured and unsecured debt of less than $2,725,625 is eligible to file under the SBRA. See Section 101(51D).